JPMorgan: Strong Yield And ~15% Upside For 2015

| About: JPMorgan Chase (JPM)
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Summary

JPM has performed very strongly since recovering from the London Whale incident.

Considering the headwinds to JPM's business it is incredibly impressive the bank has continued to deliver growth.

I think JPM is worth $66 right now.

Shareholders of financial services giant JPMorgan (NYSE:JPM) have had plenty to deal with in the past few years. Between the London Whale incident (remember that?), the Fed relentlessly pouring more regulation upon the entire industry and general unhappiness with banks from the public, JPM has weathered the various storms quite well. The stock's enormous gains of a couple years ago have given way to slow, steady gains in the past year, but gains continue to build nonetheless. In light of JPM's multi-year rally and the plateau that appears to be forming now, I will take a look at JPM's valuation to see if it is still the world class bank stock we have become used to or if investors should take $60 and deploy that capital elsewhere.

To do this I'll use a DCF-type model you can read more about here. The model includes inputs such as earnings estimates, sourced from Yahoo!, dividends, which I've set to grow at 3% yearly and a discount rate, which I've set at the 10 year Treasury rate plus a risk premium of 7%.

2013

2014

2015

2016

2017

2018

2019

Earnings Forecast

Prior Year earnings per share

$4.35

$5.46

$5.95

$6.37

$6.83

$7.32

x(1+Forecasted earnings growth)

25.50%

9.00%

7.13%

7.13%

7.13%

7.13%

=Forecasted earnings per share

$5.46

$5.95

$6.37

$6.83

$7.32

$7.84

Equity Book Value Forecasts

Equity book value at beginning of year

$53.25

$57.11

$61.41

$66.09

$71.17

$76.69

Earnings per share

$5.46

$5.95

$6.37

$6.83

$7.32

$7.84

-Dividends per share

$1.60

$1.65

$1.70

$1.75

$1.80

$1.85

=Equity book value at EOY

$53.25

$57.11

$61.41

$66.09

$71.17

$76.69

$82.67

Abnormal earnings

Equity book value at begin of year

$53.25

$57.11

$61.41

$66.09

$71.17

$76.69

x Equity cost of capital

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

=Normal earnings

$4.79

$5.14

$5.53

$5.95

$6.41

$6.90

Forecasted EPS

$5.46

$5.95

$6.37

$6.83

$7.32

$7.84

-Normal earnings

$4.79

$5.14

$5.53

$5.95

$6.41

$6.90

=Abnormal earnings

$0.67

$0.81

$0.85

$0.88

$0.91

$0.94

Valuation

Future abnormal earnings

$0.67

$0.81

$0.85

$0.88

$0.91

$0.94

x discount factor(0.09)

0.917

0.842

0.772

0.708

0.650

0.596

=Abnormal earnings disc to present

$0.61

$0.68

$0.65

$0.62

$0.59

$0.56

Abnormal earnings in year +6

$0.94

Assumed long-term growth rate

3.00%

Value of terminal year

$15.60

Estimated share price

Sum of discounted AE over horizon

$3.17

+PV of terminal year AE

$9.30

=PV of all AE

$12.47

+Current equity book value

$53.25

=Estimated current share price

$65.72

We can see that the model produces a fair value of about $66, or around 12% higher than shares trade for today. That would imply that JPM is moderately undervalued right now, but what exactly does it mean? The model produces a price at which investors can get long a stock and be afforded some margin of safety. Given that JPM is well below that price, a huge margin of safety is implied at current levels. And with JPM's business continuing to grow in the last year while the stock has stagnated, that should make some sense. But let's look more closely to see what we're dealing with.

JPM is the premier banking franchise in the country, and in many parts of the world. The century-old firm has deep, prestigious roots in the birth of modern finance thanks to its founder and in the decades since, subsequent management teams have done nothing but grow the business and make lots of money for shareholders. That includes JPM's current CEO, Jamie Dimon, who I believe is probably the best CEO in banking and has been for years; a list that includes many men for whom I have deep respect as leaders, including Stumpf (NYSE:WFC) and Blankfein (NYSE:GS), and have proven to be winners over the long term. This fact cannot be understated as strong leadership and a team that knows how to weather the storm and produce results even under adverse conditions is worth however many millions of dollars they are paid each year. Part of the reason why I like JPM is because of who their CEO is.

It is this leadership that I believe has kept JPM on track through the trials I mentioned in the open, plus many more I haven't mentioned, not to even speak of the seemingly never ending ZIRP from the Fed that has kept rates at rock bottom lows for years now. The leadership team has been able to position JPM with diversified sources of revenue that don't dry up when housing tanks or rates plummet; this is a well structured business that is on par with WFC's rock solid balance sheet, albeit in different ways.

In terms of valuation I think JPM is still cheap despite its multi-year rally. That rally, however, has shown signs of fizzling out somewhat as the stock has really traded largely sideways in 2014. But that doesn't mean the stock isn't worth a look. At $58 JPM is trading for only 10 times forward earnings, a traditional banking multiple but one that I feel is low given JPM's ability to execute in tough environments, its diversification and its leadership team. I think 11 or 12 times forward earnings is far more appropriate and if it keeps getting cheaper, consider it a gift. JPM is a premium franchise and deserves to trade higher than the rest of the pack.

We can see in this chart from YCharts that JPM's price to book value has climbed out of the London Whale trough strongly to trade near its multi-year highs.

However, a franchise as strong and resilient as JPM should trade more towards the 1.15 or 1.20 area, an area it has historically traded at, and that leaves room for expansion in the price. We can see the P/B ratio dip off of the highs of early 2014 and that is due to a static price but growing book value; this is a favorable setup for investors.

We can also see that JPM has held its own against its peer group of Dow 30 (NYSEARCA:DIA) stocks in recent years.

After the London Whale dip the stock took off higher against the market but has leveled out since. But with the market making all-time highs there are worse things that can happen. What I think we'll see in 2015 is JPM shares catch up to the valuation that has built in 2014 and is forecast for 2015. We'll see JPM outperform the market once again.

JPM has the total package. The company has strong leadership, a strong, diversified business and a valuation that has become cheaper as the company has continued to grow the business. It also pays a very nice 2.6% dividend that beats many other dividend stocks out there today. JPM offers a very nice blend of potential upside and income although I'd hesitate to call it an income stock. Nevertheless, I think JPM's fair value right now is 11 times next year's earnings, corresponding to ~1.15 times book value, or about $66. JPM should continue to drift higher in 2015 and is a great core holding.

Disclosure: The author is long JPM.

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.