Why JPMorgan Is Still A Strong Buy

| About: JPMorgan Chase (JPM)

In May of 2012 JPMorgan Chase (NYSE:JPM) failed to properly monitor its derivative trading unit and its exposure to the market, which ultimately that led to a $6 billion loss for the bank. When news of this failed trade was made it was coined the 'London Whale'. Since the Whale incident the bank has been under intense pressure from both regulators in the U.S. and the U.K. This has all been coupled with ongoing accusations that the bank was involved in pushing faulty mortgages. Investigators from the SEC, U.S. Justice Department, and several state governments have all filed charges against the bank on this basis.

Consequently, these investigations have made investors very nervous about the longer-term financial impacts on the company and stock. As the estimated impending charges brought against JPMorgan have continued to mount the company has been unable to return a great deal of value back to shareholders. This has resulted in investors leaving the stock and moving on to some of JPMorgan's competitors like Wells Fargo (NYSE:WFC), Bank of America (NYSE:BAC), UBS or Citigroup Inc. (NYSE:C) to gain some banking exposure in their portfolios.

The good news for shareholders this week was that it was announced that JPMorgan would settle the 'Whale Trade' for $920 million. Of the $920 million being paid out, $200 million will go to The Securities and Exchange Commission. The Federal Reserve Board will receive $200 million, and the Office of the Comptroller of the Currency will get $300 million. Finally, the British regulator will receive $220 million for its imposed fine. As for the ongoing investigations surrounding the faulty mortgages JPMorgan is meeting with the Justice Department this week in the hopes of trying to come up with a final settlement amount bringing all charges that are still pending to a final resolution.

It hopes to try to prevent a BP plc (NYSE:BP) like event that involves the company being involved in continued ongoing payments that never seem to end and that depress shareholder value. JPMorgan's talks with the Justice Department are still very new, but the move is pivotal to future growth and value. No official word has been released as of yet on what the final settlement number will be, but initial estimates are coming in at around $11 billion in total charges. Of the total $11 billion in charges, $7 billion of that would be in cash, while the remaining $4 billion would go back to consumers affected by the faulty mortgages. When and if JPMorgan is successful in getting this suit settled I see a lot of positive outcomes for the bank and stock.

Even under the new financial regulatory environment JPMorgan continues to be very good at making money. JPMorgan in its most recent quarterly filing reported net income of $6.5 billion or $1.60 per share and operating cash flow of $67.13 billion. As positive as those numbers may be the firm is still not able to return the level of shareholder value that it would like. Since the financial crisis JPMorgan has been able to reinstate its dividend and has finally gotten its quarterly payments to be back to where they were in 2008 before the crisis. Additionally, the company this last March initiated a share buyback program of $6 billion that would extend for the next 12 months.

The stock for the last year has basically traded flat at around $50 per share even though it has a current book value of $55.50 per share. Assuming that the average share buyback price of the $6 billion is around $50 per share that would equate to 120 million shares being repurchased, reducing the outstanding float from 3.77 billion to 3.65 billion, creating a new book value of $57.30 per share, assuming all other things were equal.

Before the 'Whale Trade' the bank had been authorized to initiate a share buyback of twice the size of the existing $6 billion, but due to all of the uncertainty of the 'Whale Trade' the bank has had to reduce its contributions. In the last quarterly call the company stated that the bank currently spends roughly $2.5 billion a year on legal costs due to the poor trade and other mortgage related grievances. Given that those expenses could continue to grow as more people and governments jump on the band wagon, that $2.5 billion dollar amount has the potential to grow exponentially.

Additionally, CEO Jaime Dimon has stated that the bank continues to need to postpone any new projects that could further return shareholder value or expand business operations until the bank could put its house back in order. This all comes after the company said earlier this year it could possibly face legal costs in excess of $6.8 billion.

In order for JPMorgan to remain competitive in the industry, increase shareholder value, and expand its business it will be imperative for a deal to be reached with the Justice Department. As the economy faces rising interest rates the banking environment will begin facing even more challenges. Historically, JPMorgan has usually done quite well for itself in a rising interest rate environment, but given the amount of time and capital it is currently using on litigation, it's anyone's guess how it will do this time.

Personally, I am confident that the Justice Department and JPMorgan will come together on some kind of deal. Since news broke that the company was in talks trying to strike a deal I have been buying more of the stock every time it dips below $51 per share. The stock seems to have strong support around the $50 - $51 dollar level and I feel that once a deal is reached and announced the stock will jump and push through the $55 per share level and test its 52-week high. The cash flow, dividend, and dedication to shareholders that JPMorgan has continually displayed is a major selling point to me as an investor and I feel that an entry point today in the stock will prove to be a wise investment in a few years, as the company will then be free to fully deploy all of its cash and potential to deliver shareholder value. Not to mention that the company currently is trading below its book value, which for a value investor is a clear buy signal.

Overall, I remain bullish on JPMorgan and I feel that all of this anxiety around a deal being reached has created a great deal of volatility and an excellent buying opportunity to begin building a longer-term position in a great company and strong stock that has a great deal of potential.

Disclosure: I am long JPM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.