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Summary

  • JPMorgan shares have been battered since hitting highs in April.
  • Sentiment has been terrible and shares are now pricing in very low earnings growth.
  • Shares appear to have made a bottom around $53.

JPMorgan (NYSE:JPM) shares have been hammered since hitting their highs in April, as you can see in the chart below from StockCharts, along with the rest of the banking sector. There are many factors in play here but the warning on trading revenue certainly didn't help matters. However, with shares trading down roughly 10% from their highs, and pretty violently at that, was it an overreaction by market participants?

(click to enlarge)

To determine if JPM is cheap, I'll use a DCF-type model that you can read more about here. I used analyst estimates from Yahoo! Finance, dividend growth of 8% per year, and a discount rate of 9%, which I believe fairly reflects a risk premium for JPM shares. All of these inputs are open to interpretation but I feel the values I selected are fair representations of reality.

2013

2014

2015

2016

2017

2018

2019

Earnings Forecast

Prior Year earnings per share

$4.35

$5.42

$6.03

$6.33

$6.65

$6.98

x(1+Forecasted earnings growth)

24.60%

11.30%

5.00%

5.00%

5.00%

5.00%

=Forecasted earnings per share

$5.42

$6.03

$6.33

$6.65

$6.98

$7.33

Equity Book Value Forecasts

Equity book value at beginning of year

$54.06

$57.88

$62.18

$66.65

$71.29

$76.09

Earnings per share

$5.42

$6.03

$6.33

$6.65

$6.98

$7.33

-Dividends per share

$1.60

$1.73

$1.87

$2.02

$2.18

$2.35

=Equity book value at EOY

$54.06

$57.88

$62.18

$66.65

$71.29

$76.09

$81.08

Abnormal earnings

Equity book value at begin of year

$54.06

$57.88

$62.18

$66.65

$71.29

$76.09

x Equity cost of capital

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

=Normal earnings

$4.87

$5.21

$5.60

$6.00

$6.42

$6.85

Forecasted EPS

$5.42

$6.03

$6.33

$6.65

$6.98

$7.33

-Normal earnings

$4.87

$5.21

$5.60

$6.00

$6.42

$6.85

=Abnormal earnings

$0.55

$0.82

$0.74

$0.65

$0.57

$0.48

Valuation

Future abnormal earnings

$0.55

$0.82

$0.74

$0.65

$0.57

$0.48

x discount factor(0.09)

0.917

0.842

0.772

0.708

0.650

0.596

=Abnormal earnings disc to present

$0.51

$0.69

$0.57

$0.46

$0.37

$0.29

Abnormal earnings in year +6

$0.48

Assumed long-term growth rate

3.00%

Value of terminal year

$8.07

Estimated share price

Sum of discounted AE over horizon

$2.60

+PV of terminal year AE

$4.81

=PV of all AE

$7.41

+Current equity book value

$54.06

=Estimated current share price

$61.47

As you can see the model produces a fair value of $61.47 using the inputs I described. It is important to understand this is not a price target; rather, it is a fair value that one could pay for shares today and get the present value of the company's future earnings and dividends.

There is a big difference between the $54 shares are currently trading for and the $61+ fair value I've just assigned to shares so let's take a look at what has happened. First, as we saw in the chart above, sentiment on the banks has been terrible for weeks now. Most of the big banks have been hammered for one reason or another and their charts look pretty similar to JPM's. However, JPM had no stress test issues and it is still making enormous amounts of money. Litigation is an issue for JPM, as it is for every other large bank, but the worst appears to be past the House of Dimon. Thus, I think this selloff, like the one in Bank of America (NYSE:BAC) shares, is overdone and is an emotional reaction to news items instead of an objective measure of the company's situation.

If you look at the model I'm using some pretty conservative estimates in order to come up with my fair value. Most notably the analyst estimates are only pricing in 5% earnings growth over the medium term, potentially leaving plenty of room for upside surprises later on. However, what's more intriguing is that if I solve for the current value of JPM shares by changing the earnings growth rate, it shows JPM shares are currently pricing in 2% earnings growth over the medium term.

As an investor, you have to ask yourself if you think the premier bank in the world can produce 2% earnings growth over the medium term and if the answer is yes, shares appear to be a buy right now. My model is suggesting significant upside to today's prices and to be honest, I don't see it as an unreasonable value. Shares were trading at my fair value just a few weeks ago and the reasons they have come way down off the highs really aren't good reasons, in my view. I think the situation is far less dire than investors apparently do and I think it represents an opportunity to pick up a great dividend stock with some capital appreciation potential.

JPM is the premier banking franchise in the world and shares have been unfairly punished of late. While some selloff from the highs should have been expected I believe Mr. Market has gotten this one wrong. Shares appear to have set a bottom at $53 or so and as such, I think we will see some upside. We have seen this before from JPM; news items drive the stock lower and then once it passes, shares move up again. I believe we'll see a similar situation this time around as well. If you think JPM can best 2% earnings growth over the medium term and you like 3% yielding stocks, JPM just may be for you too.

Source: JPMorgan: Is 2% Earnings Growth Too High?