This continues on from my last article. Last time I went over two riskier bank stocks, and this time I will go over two that I find more suitable for a conservative strategy. The two banks are Wells Fargo (WFC) and JPMorgan Chase (JPM). I feel that these bank stocks are not undervalued, and therefore they need far more suitable economic conditions and really solid business decisions in order to increase their value.
This will be a tricky one to nail down trades for, because it is hard to be sure if there are good entry points if they are fairly valued. Last round I had a trade idea and an option trade idea. This time, I think I am just building a platform from which to dive deeper into the intricacies of each business. It is only after understanding the long term course of the stocks will I commit to a course of action. So for this round I will go over the fundamental metrics, and maybe if I see that a trade opportunity is forming I will analyze the company in greater depth.
The last part of this series is here. I took it off Seeking Alpha as there is very little to add, and I did not feel like cluttering the place up.
The Numbers - Wells Fargo
Wells Fargo is probably the bank stock I would be most likely to sock away for a long time. This article will not cover all the research necessary for me to make my decision, but it will create the platform to base subsequent analysis. Two things that I will need to go over after I go over the fundamental metrics are the future business potential for Wells Fargo, and the overall macroeconomic climate for bank stocks. Future business is so unique to each company, that it would make a comparison between these two stocks unnecessarily lengthy, and looking at the overall economy is almost a dissertation in its own right. For this article I will keep it focused to comparing fundamentals so it remains coherent.
First, the price-to-book ratio for Wells Fargo is 1.349, which makes it the leader in this category compared to its peers. It is the winner by a large margin. This is exactly what knocks it out of the undervalued round, however I would be worried if Wells Fargo were not such a great company. I may not have taken a deep look recently, but I have read enough to know that Wells Fargo is a solid bank that does a good job of being a bank. If Wells Fargo continues on its solid course it should maintain the P/B ratio whilst the price appreciates. The P/B ratio has been in a tight range for a while, with just some forays higher and lower.
Wells Fargo's net income TTM is fantastic at $16.15B. I mentioned I liked TTM because it takes the wild swings out. What is more impressive than the absolute number is the trend. That is a beautiful chart showing improving net income. You can also take a look at earnings per share TTM to see the effect over time. Remember each data point on TTM is 4 quarters of data and this rolls forward. That way one poor quarter does not scare you away as long as the recent trend has been good. Wells Fargo has had improving quarters that is why the net income TTM trends up.
Wells Fargo has a beast of a profit margin at 19.48% which I noted in the last article. This is about as high as it has ever been in the last 10 years so I would not be looking for improvement on this front. Wells Fargo will need to pull down more revenue in order to increase profits and cash. I also think the market has factored in the great profit margin so I would not be looking for any psychological bumps.
Therefore, we must look at revenue growth. It sits at 2.33%, which might seem paltry, but at least it is positive. Most of the other big banks, minus Bank of America (BAC), are suffering from negative revenue growth. Wells Fargo had negative revenue growth not too long ago, but hopefully it can stay positive into the future. I would also like to see it increase at a faster clip soon as well. I would be happy with 4-5% consistently.
Non-performing assets are like a black hole on a balance sheet. These assets are chiefly responsible for the sometimes overstated books of banks when they are not flushed from the balance sheet. Wells Fargo has non-performing assets totaling about $25B, which is down $1.8B from the prior quarter. All the banks have non-performing assets that amount to about a tenth of the fortune I would want. That is a joke. I am not that greedy. The point is that it is a normal part of business. I just do not want to see non-performing assets spiraling out of control. There are a couple of other good signs in that link, such as net charge-offs dropping. You can take a look of these on your own.
The last thing is cash, long term debt, and free cash flow. I always like to see more cash than long-term debt, and we have that here. However, cash is kind of low overall compared to the other national banks. At least it has gone up in recent history. Free cash flow is great at almost $20B.
I know this analysis does not include much of a revelation. There is no little nugget that will change everything regarding this stock. I do not expect Wells Fargo to reinvent banking though. All we have is a lot of data. This data tells me that Wells Fargo is a strong company, but it also tells me that it is known to be a strong company. Therefore it is not really undervalued, and that makes finding an entry tricky for someone who only thinks short term. In the long run, Wells Fargo can just grow and appreciate or return money to shareholders via a dividend. The P/E on Wells Fargo is in line with its peers so I would be looking for earnings to go up rather than price going up alone.
I will say one thing that is not from the fundamental metrics. I think there is still some benefit to come from the Wachovia purchase, or merger however you want to classify it, and the recent macroeconomic doldrums have delayed that benefit. That is something I would like to explore in a future article, but my cursory analysis is that the unification would create some downside for a few years as the better business seeks to cut away the dead bits. I see Wells Fargo as having bought an infrastructure with which to grow. I expect the real benefit from utilization of that infrastructure to come when the economy finally starts moving. However, a more detailed look is on my to do list.
The Numbers - JPMorgan Chase
Is it bad that the recent bad press JPMorgan has gotten makes me like it less than Wells Fargo? There are other reasons to like Wells Fargo as well, but if I had to decide a tie I would go with Wells Fargo. Something about the massive trading loss rubs me the wrong way. Perhaps, I am not being fair but if I am nervous then I might as well not invest.
The price-to-book ratio for JPMorgan is 0.8468. This is the level I want with Bank of America or Citigroup (C). Since I do not think JPMorgan is as solid as Wells Fargo, I would choose Wells Fargo over JPMorgan. There really is not much else to say in this regard. I feel like JPMorgan is at least as fairly valued as Wells Fargo, and other factors point me away.
JPMorgan has the highest net income TTM of the lot, at $16.58B. However, this is almost the same as Wells Fargo's net income TTM and I would just treat them as equal. The trend on this metric is good for JPMorgan, though it seems to have flattened a bit recently. Plenty of time for the market to price in the net income TTM. I like Wells Fargo's trajectory better.
JPMorgan's profit margin is good too at 18.44%. That is high like Wells Fargo's. JPMorgan only recently attained its profit margin, but it is pushing the limits of the last 10 years. I think JPMorgan has the ability to increase revenue in order to increase profits, but I just believe in Wells Fargo more. My perception may be colored by their not-so-old headlines. I just wonder what other skeletons they have locked in their vault. I might be too jumpy, but bad news is severely punished in today's tough markets. Granted JPMorgan did not really suffer too much from their large trading loss but more bad news would not be welcome.
JPMorgan had a -17.80% revenue growth rate for June 2012. That is a scary number. More importantly look at the table at the bottom. It is at -17.80% after being 1.13% after being -17.61%. If you go back further in time you will see the swings that are mirrored in the chart. I do not like that much inconsistency. JPMorgan had a 1% reprieve between two -17% declines. As far as this conservative round goes, those revenue growth numbers do not scream safe to me. Safety is relative, but still I do not like the swings.
Cash and long term debt look good for JPMorgan. It has ample cash almost 4 times its long term debt, so no flags there. Free cash flow is massive at about $42B. Free cash flow does fluctuate a bit, though there might be very good reasons such as putting cash to work instead of adding it to the coffers. The P/E ratio is a bit lower than peers but still in the same neighborhood, so I would not look to that as a saving point.
There really is not too much here to turn one away from a JPMorgan investment. I prefer Wells Fargo for various reasons. I think Wells Fargo did a solid job of navigating the credit crisis, and it avoided some of those riskier mortgages. Obviously all the banks had questionable loans, but Wells Fargo did not make this into their substantial business, unlike Citigroup or Bank of America for example. With that in mind, if I was going to choose a company that I wanted to invest in and sock away shares for the long haul I will be going with Wells Fargo. JPMorgan's negative press and swinging revenue growth turn me away. It might be a small thing to turn away from an investment, but there has to be a loser. I do not want to invest in every bank stock.
No real trade ideas at this point, though I do have some thoughts. I say no trade ideas, but this is still a long themed article. A trade for me has an entry and specific targets in a certain amount of time, but for Wells Fargo I would say that going long is a good option, but I do not know when and where it will go to any degree. Bank of America was simpler because I felt it was so undervalued, and its options presented such a great opportunity.
I would use options to go into Wells Fargo. I would take one half of my long position through writing puts. I would write them at $33 a few months out. I have not decided how many months out I would do this, but I would keep rolling this forward at $2-$3 dollars behind the current price and collect the premiums.
I still want more research about Wells Fargo before I really go in. I am actually very interested in the long term benefits from the Wachovia merger. I would also want to compare these to JPMorgan's acquisition of Washington Mutual. My perception is that Wells Fargo grabbed the bigger but weaker bank, and the merger was more among equals. JPMorgan got a bank that was weakening, but mostly due to panic not because of toxic assets, at least to the extent of Wachovia. Also, it seems to me that JPMorgan was the massive bank swallowing a smaller bank. This is all just a cursory look, and I think I will go into it more one day.
I did not look at revenues from loans vs. fees, but I just felt it was getting too much into the specific businesses of each bank. At their very core banks are lenders. I chose to focus on this. I did add non-performing assets this time, which is good for this round because for fairly valued companies it really is important. That potential black hole on the balance sheet can do a lot of damage.
In moving onto the finale remember that most of these banks have recovered from a large thrashing. I do not think any of them are going to zero. If they do fail we have far larger problems. I needed to choose one or two banks that I liked. Hence, the final round was created. No need to choose just one, I could invest in the top 2, but I do not want to be overexposed to banks.
This is the starting point of further research. Once you have your favorites from a fundamental standpoint you can look into the core businesses. I like this strategy because I would hate to do all this research and find out that a fundamental metric is telling me to run and hide.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: It will take me more than 3 days to come to any decision. That includes BAC and C. Remember to do your own due diligence. This is a starting point.