Parsing The Recent Bad News: Financials Are Undervalued

Includes: AAPL, AIG, BAC, C, CSCO, FB, GS, JPM
by: Global Value Investor

Uncertainty is back. And it hit investors right in the face and from all sides: Greece is likely to leave the eurozone, a socialist was elected in France, Spain's banks were downgraded, JPMorgan (NYSE:JPM) suffered derivatives losses and the Facebook (NASDAQ:FB) IPO failed. A lot to take for investors, or, in other words, a great time to buy.

Negative news has dominated the headlines for a few weeks now, which led investors to sell-off stocks in a big fashion. Cisco (NASDAQ:CSCO) had to sacrifice some billions in market capitalization after its earnings release last month (which was good nonetheless) and even Apple (NASDAQ:AAPL), which has held up quite nicely over the recent past, is down about 12% since April.

I am short AAPL as a portfolio hedge and because I am influenced by who the marginal investor in AAPL stock is. The shareholder profile is less stable as short-term oriented speculators drove up the stock price. With the stock running up from $400 to $644, it is evident to me that emotions will be more critical going forward than fundamentals, implying a larger volatility probability. Besides, AAPL will eventually run into constraints with its growth rates and will eventually disappoint. The marginal investor is not a long-term holder of common stock but a rather shaky momentum trader.

As I noted in my FB article, I have never believed in FB's IPO. There were just too many insiders trying to rip off retail investors (which is usually the case with the involvement of private equity investors who demand healthy premiums leaving bad implicit growth prospects for the IPO subscribers).

I predict Greece to dominate the news going forward, which does not faze me at all. Traders who believe in a scenario of Greece leaving the eurozone should consider shorting the euro as investors will equate Greece's departure with a dissolution of the European currency zone leading to a massive euro sell-off.


JPM's unexpected loss warning surely inserted another level of intensity into the debate and bringing regulatory issues back to the headlines again. The notion that JPM's share repurchase program might be halted because of the uncertainty associated with the failed derivatives bet is clearly a negative - in the short-term. It does not affect the long-term earnings viability and fair resilience of JPM's business.

JPM reached a 52 week high at $46.49 just before the recent announcement of trading losses. Shares are trading about 27% down since then. The rational investor should ask whether this is an accurate reflection and evaluation of the current situation: Since the end of March, the market has wiped out around $48 billion in market capitalization, partly because of the trading losses. I think this is a too extreme, too-pessimistic evaluation of the current status quo. I also think this valuation is unreasonable as the underlying earnings prospects are not deteriorating. I believe JPM could surely reach $70 in a few years once everybody is all holding hands with banks again.

The average earnings estimate for JPM's 2013 earnings is $5.48 per share, leading to a forward P/E ratio of 6.2x. This clearly is a depressed multiple. A market that assigns an earnings multiple of only 6x to a company that made an example out of itself during the financial crisis is unreal. I have held JPM common stock before the recent news and I am adding to my position.

Goldman Sachs (NYSE:GS)

I have continued to add to my position over a period of two years now and I am confident in GS being able to achieve a historical P/B valuation of 2 over the long-term. Goldman Sachs currently trades at a forward P/E of 7.15 which is clearly too low given its competitive position and earnings strength. I believe GS should trade more like $200 a share, bringing it in line with a historical book valuation multiple of two. This line of thinking also goes for Citigroup (NYSE:C), Bank of America (NYSE:BAC) and AIG (NYSE:AIG).

In general, I cannot really understand why the market assigns such low multiples to the financial sector four years after the financial crisis. Multiples will likely increase more when the economy makes better daily headlines, which is why value investors should think about an investment now rather than later.

Disclosure: I am long C, BAC, AIG, JPM, GS, CSCO.