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Summary

  • JPMorgan shares are still trading below fair value.
  • The bank's yield and excellent management make it a buy.
  • Although shares have closed the value gap somewhat there is still plenty of room to run.

The last time I visited JPMorgan (NYSE:JPM), shares had been pummeled as trading revenue had been exposed as being weak (remember that?) and sentiment for all banks was horrendous. JPM touched $53 just prior to my article and at the time, I concluded that JPM was being priced for 2% earnings growth. Obviously, I found that to be unreasonable and posited that shares had bottomed at $53. Fast forward to today and JPM shares are trading for more than $56 on the back of a terrific second quarter and improved sentiment including the largely forgotten trading revenue issue. The question investors are facing now is whether or not the bounce was the end of the rally. In this article, we'll take a look at JPM's earnings expectations now in relation to its valuation.

(click to enlarge)

To do this, I'll use a DCF-type model you can read more about here. In essence, the model uses inputs such as earnings growth rates, which I've sourced from Yahoo!, dividends, which I've set at 8% growth per year, and a discount rate, which is set at the 10 year Treasury rate plus a risk premium of 6.5%. These estimates should give us a fair look at JPM's valuation in relation to its earnings prospects.

2013

2014

2015

2016

2017

2018

2019

Earnings Forecast

Prior Year earnings per share

$4.35

$5.50

$5.96

$6.23

$6.51

$6.80

x(1+Forecasted earnings growth)

26.40%

8.40%

4.50%

4.50%

4.50%

4.50%

=Forecasted earnings per share

$5.50

$5.96

$6.23

$6.51

$6.80

$7.11

Equity Book Value Forecasts

Equity book value at beginning of year

$55.53

$59.43

$63.66

$68.02

$72.52

$77.14

Earnings per share

$5.50

$5.96

$6.23

$6.51

$6.80

$7.11

-Dividends per share

$1.60

$1.73

$1.87

$2.02

$2.18

$2.35

=Equity book value at EOY

$55.53

$59.43

$63.66

$68.02

$72.52

$77.14

$81.90

Abnormal earnings

Equity book value at begin of year

$55.53

$59.43

$63.66

$68.02

$72.52

$77.14

x Equity cost of capital

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

=Normal earnings

$5.00

$5.35

$5.73

$6.12

$6.53

$6.94

Forecasted EPS

$5.50

$5.96

$6.23

$6.51

$6.80

$7.11

-Normal earnings

$5.00

$5.35

$5.73

$6.12

$6.53

$6.94

=Abnormal earnings

$0.50

$0.61

$0.50

$0.39

$0.28

$0.17

Valuation

Future abnormal earnings

$0.50

$0.61

$0.50

$0.39

$0.28

$0.17

x discount factor(0.09)

0.917

0.842

0.772

0.708

0.650

0.596

=Abnormal earnings disc to present

$0.46

$0.51

$0.39

$0.27

$0.18

$0.10

Abnormal earnings in year +6

$0.17

Assumed long-term growth rate

3.00%

Value of terminal year

$2.75

Estimated share price

Sum of discounted AE over horizon

$1.81

+PV of terminal year AE

$1.64

=PV of all AE

$3.45

+Current equity book value

$55.53

=Estimated current share price

$58.98

The results of the model show a current fair value of about $59. In comparison to the current share price of $56 and change, shares appear to be a relative value. But before we get too far, we need to understand what the model is saying.

Basically, the model discounts a company's return on its assets over and above the discount rate and then computes the fair value. The fair value is not a price target; rather, it says that JPM shares are a relative value at any price below $59. In other words, shares are trading ~$2.60 below their indicated fair value, which is a good start.

Last time I wrote about JPM shares were trading for $54 and the fair value my model produced was over $61. As a contrast, we're at $56 and $59, respectively, for the same numbers. So what has caused the divergence? The first one is obvious; shares have traded up since my last recommendation to buy. The second is less obvious. JPM's earnings projections have come down since then, reducing the fair value of JPM's earnings stream. However, we are still trading well below the projected fair value with the updated, more pessimistic earnings projections.

I mentioned JPM's second quarter and it was terrific. Revenue and earnings were strong beats and the bank returned a total of $3 billion to shareholders via dividends and buybacks. Mortgage originations fell off a cliff but that was to be expected and JPM cut staff in that area in preparation, mitigating some of the damage. And while trading revenue was predicted to be slow again in the second half, a major bright spot was business banking where originations were up 46% over last year. While the quarter had some good and some bad, the overall result was terrific and shares rose in kind. JPM is perhaps the best managed of the mega banks and it showed last quarter amid a less-than-favorable environment for banking.

What you have to ask yourself in reference to this analysis is, given the information we received in the most recent earnings report and what we already knew about JPM and the environment for banking, do you think the company can achieve 4.5% earnings growth over the medium term? I suspect that target is very achievable and while I expect there will be down years - there always are - I think JPM is extremely well positioned to deliver earnings growth in the mid-single digit range going forward. The company has one of the best CEOs in the country - not even just in banking - and its strategic direction is terrific. In other words, even though the spread between the company's fair value and its current price has compressed, I think there is still value in JPM going forward. If you're looking for a nice yield and a stable stock with great management, JPM could be for you.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in JPM over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: JPMorgan Revisited: Still Cheap And Attractive At These Levels