After news emerged that JPMorgan's (JPM) trading loss may be $7B higher than originally expected, the stock has fallen by 4% after trading hours. In my view, the leading investment bank has been unreasonably hit over the last three months given the erasure of 20% in shareholder value. In regard to the trading loss, JPMorgan generated nearly $100B in operating cash flow last year and shouldn't be discouraged from taking risk when it is wise to do so. Mistakes occur, but JPMorgan has been overall successful where it has taken risk. The company still has impressive fundamentals in an industry where brand is king.
JPMorgan has also taken meaningful steps to improve liquidity and boost capital ratios. The price to free cash flow is at 1.4x and the current PE multiple is less than half of the historical 5-year average. Jamie Dimon has been an excellent manager of the financial giant and unfortunately had to endure unwarranted political criticism. He has built a fortress balance sheet that considerably reduces risk beyond what the market recognizes.
Financials are undervalued as a whole. Morgan Stanley (MS), Citigroup (C), and Goldman Sachs (GS) also merit investments. Morgan Stanley has boosted its Tier 1 Capital Ratio to 16.8% and this comes with the added benefit of less regulatory risk. Fixed Income has picked up momentum from added balance sheet velocity and momentum. Consensus expectations also anticipate EPS taking off by the high double-digits over the next three years. Assuming a 10.5x multiple and a conservative 2013 EPS of $2.38, the stock will rise to nearly $25.
Citigroup is an attractive value investment given how it is only worth one-twentieth of its value just 5 years ago. In my view, the shell of a financial giant is still there and this is complemented by low downside from the 7.4 PE multiple. The low dividend yield and high 2.6 beta add a layer of risk that will help fuel outsized returns as the global economy moves towards full employment. The firm completed its "living will" ahead of the July 1st deadline, which possibly signals that it will simplify the business.
Goldman Sachs is a hallmark of American finance led by top management. Net revenues of $10B in the first quarter were impressive with the investment banking business up 35% from y-o-y. Goldman has lost almost 30% of its value over the last 12 months despite better-than-expected performance. Weakness in the 2Q11 and 3Q11 were dwarfed by strong execution in 1Q11, 4Q11, and 1Q12. Growth is expected to be high in the near future with the financial giant hitting $12.86 EPS in 2013. At a 11.5x PE multiple, this puts the future value of the stock at nearly $150. Discounting backwards by 10% yields a present value of $122.22 per share. This is roughly a 35% premium to the current market value on top of a 2% dividend yield. I thus strongly recommend an investment in Goldman along with broad diversification in financials.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
