Since the beginning of the year, JP Morgan (NYSE:JPM) has risen nearly 18% in a move that has added nearly $40 billion in value to shareholders. This increase in share price comes despite politicians questioning the firm, the Federal Reserve tapering its mortgage-backed security purchases, and the overall economy experiencing downward restatements. In this article, I will present the case that JP Morgan is a strong stock that investors should consider adding to their portfolios.
A History of Returns
When evaluating a company, an analyst would do well to isolate a few fundamental drivers of stock performance. By limiting our analytical efforts to a narrow spectrum of comprehensive fundamental indicators, we can focus on clear relationships between firm performance and stock performance. In this article, I have relied heavily on return on assets to arrive at an objective measurement of JP Morgan's performance. Return on assets is calculated by taking the net income in a given period and dividing it by average total assets across an operating cycle. The usefulness of this metric is that it allows the analyst the ability to examine earnings in light of the capital base required to generate these earnings. Firms that are in periods of growth tend to experience increasing return on assets and the converse is true for firms in decline. Since JP Morgan is an investment bank, nearly 70% of its assets are composed of long-term investments. The category of long-term investments is a comprehensive descriptor for fixed or floating income lending activities. The significance of the fact that 70% of assets are similar to loans means that as we examine return on assets, we are examining how well JP Morgan is actually able to generate profits from its lending endeavors. The chart below shows 5 years of return on assets for JP Morgan.
The chart above shows four distinct periods in the economic history of JP Morgan. In the discussion below, we will explore these periods to arrive at an investment decision. The table below summarizes the discussion.
- The first noteworthy period of performance was the second quarter of 2008 until the first quarter of 2009. This time period was marked by a traumatic global meltdown in the financial system, which greatly impacted the investment banks. During this time period, Lehman Brothers, Bear Stearns, AIG, and Merrill Lynch, among others were either forced into bankruptcy or required a bailout of some form. Surprisingly, during the storm, JP Morgan weathered fairly well in that it was not actually driven into a loss, as measured by return on assets. The variables impacting the global economy did not spare the firm, however in that shares declined nearly 45%.
- The next period of our analysis is from the second quarter of 2009 until the second quarter of 2011. During this period of time, the economy was finally able to exit the recession in that GDP growth rate once again became positive and unemployment began to decline. Since the majority of JP Morgan's assets and subsequent profits are derived from lending activities, a bettering economy means that JP Morgan experienced growing returns. The economic situation during these quarters was such that JP Morgan was able to triple its return on assets. Shareholders park capital in firms that deliver increasing returns and JP Morgan is no exception to this rule in that shares rose 40% during these months.
- The time period of the third quarter of 2011 until the second quarter of 2012 was marked by a decrease in performance at JP Morgan. Several elements such as increasing inflation with decreasing interest rates combined to cause the firm to experience declining returns. As companies experience decreasing returns, investors tend to flee the security to preserve capital. With JP Morgan however, shares continued to rise by nearly 9%. The significance of this increase is that it demonstrates the resilience of shareholders in the face of contradictory fundamental information. Specifically, investors demonstrated an underlying belief that the JP Morgan was strong despite a slight pullback in returns.
- The final period of our analysis is from the third quarter of 2012 until the second quarter of 2013. During this time period, the firm once again experienced growth in that return on assets has surged to 5-year highs. The market has shown time and again that it rewards firms with expanding returns and punishes those in decline. JP Morgan is no exception to investors' preferences as witnessed by a share price increase of nearly 39%.
The table below shows a summary of the discussion above:
The typical relationship between organization returns and share price performance is that as a firm betters itself fundamentally, its stock price tends to rise. This relationship is very strong and prevalent among many institutions, however at first glance, it appears that JP Morgan has been an exception. What is truly noteworthy about JP Morgan is that even though it has experienced a turbulent economic past, it has consistently experienced progressive increases in share price since the end of the financial crisis. It is my belief that the reason for this is internal strength and leadership at the firm. JP Morgan was able to weather the bulk of the financial crisis relatively unscathed and has been able to continue profitable operations at expanding rates. For these reasons, I believe that JP Morgan is a sound investment. In my opinion, investors should seriously consider investing with this investment bank.