Back in February of this year, I indicated that shares of JPMorgan (NYSE:JPM) appeared to be offering a "fair shake." The logic was simple enough: at price near $57, shares were trading around 9.5 times earnings with a starting dividend yield of about 3.1% (consequently equating to a payout ratio of about 30%). From that point the company didn't need to do anything extraordinary in order for investors to see solid returns.
A lot has changed since then. The share price has gone all the way from $57 up to $83.50 in just 10 months - a 46% increase during that time. Now to be fair there have been some improvements. The dividend was increased by 9% and the industry environment is certainly looking a bit more favorable.
Yet I'd contend that the "investment bar" is now much higher as well. Actually, I've already made this case when I recently highlighted that JPMorgan was no longer offering a "fair shake" at $80.
Here's the basic idea. At $57, you might have supposed that JPMorgan could grow by say 5% annually and that a future multiple of 10 or thereabouts would be reasonable. At those levels, you'd be looking at a future share price near $77 to go along with collecting $10 or so in cash dividends. Your total anticipated value would be $87, good for a total expected return of 8.8% per annum.
That's what I meant previously by "fair shake." JPMorgan didn't have to knock the cover off the ball for investors to do well.
Perhaps you can see the problem with today's share price under those circumstances. Using the same assumptions, you'd be looking at a total gain of just 4.2% in five years, or 0.8% on a yearly basis.
This brings about one of a couple possibilities: either an investment today doesn't look particularly attractive or expectations have improved with the materially higher share price. Let's explore the second alternative for illustration.
Since the recession it has been typical to see shares trade somewhere around 8 to 12 times earnings. Today, the number is closer to 14 or so. Previously, I was more content using 10 times earnings as a baseline, but there's a case to be made for a higher multiple.
At 12 times earnings, JPMorgan would need to grow per share earnings by 9.7% per year for five years in order to replicate that same 8.8% annualized expected gain that I previously detailed with the much lower share price. At 13 times earnings, this would still require a future growth rate of about 8% annually.
So in order to have the same expected returns, you have to now presume that JPMorgan is capable of perhaps 15% to 30% higher earnings in the coming half decade as compared to just a few months ago. This is possible, but the point is that the "investment bar" is now much higher as well.
JPMorgan has gone from a security needing moderate growth to sustain an investment thesis to needing rather solid growth. It's well within the realm of possibility, but investors ought to be aware of what a higher price commands. There's a lot less wiggle room at $83 as compared to $57, with a very similar underlying business.
This outline is more or less the gist of what I believe was on JPMorgan CEO Jamie Dimon's mind when he was answering questions at the Goldman Sachs Financial Services Conference.
Here's a particularly interesting excerpt:
"I personally don't believe that buying back stock is giving cash to my shareholders. I think buying back stock is giving cash to my leaving shareholders. I care much more about the remaining shareholders. And so I want that to be a bargain.
I did this thing years ago, if we buy back stock, I used analyst estimates and I said, cut it by 20%, buy back so much a year, what does it do over the 5-year period for tangible book value accretion, earnings per share accretion, stuff like that, so that is the kind of thing we'll be looking at.
I want to know when we buy back a share of stock that we are doing you a favor. And other than that, I would rather - if the stock was selling at a certain price, it makes it better [to] give you a special dividend. And we just haven't gotten there yet, because we kind of got surprised by this increase in stock price."
A personal note: by "haven't gotten there yet" I read this literally as in, haven't done the analysis yet and not that the company has concluded that the share price hasn't yet "gotten to" a price at which special dividends would outweigh repurchases.
Anyway, this is the sort of thing that ought to make you beam with pride if you're an owner of JPMorgan. So many companies buy back shares regardless of valuation. Here you have a CEO looking out for long-term shareholders' best interest and not wanting to send away leaving stakeholders with too much cash. More than that, it's about protecting and judiciously protecting your capital.
If you're not an owner, you can still file this sort of thing away in the back of your investment library. Should shares look attractive again, you have a management team that's coming to capital allocation in a sensible manner.
The second consideration that you might want to know is how much a special dividend might equate to. Obviously this is unknown, but we can come up with a baseline. Presumably, this might require some sort of regulatory approval, but there's already a buyback approval in place. Instead of handing those funds to leaving shareholders in exchange for shares, that same money could be spread out and sent to all owners.
As a starting point, back in July of this year, JPMorgan indicated that the Federal Reserve Board had not objected to its capital allocation plan of a $0.48 quarterly dividend and a repurchase authorization of $10.6 billion. JPMorgan has also highlighted its intention to pay out between 55% and 75% of earnings in the form of dividends and share repurchases.
Back then, with 3.7 billion shares outstanding, the $0.48 quarterly payout would have required $7.1 billion or so in payments. Add in the $10.6 billion in repurchases and you come to $17.7 billion or a total payout ratio of just over 75%.
In October, JPMorgan reported third-quarter results, highlighting that the company had returned $3.8 billion to shareholders - $2.1 billion in net share repurchases and $1.7 billion via the common $0.48 dividend. The share count has been reduced to 3.6 billion or so, requiring $5.2 billion in dividend payments in the coming three quarters.
While the "net" amount of share repurchases totaled $2.1 billion, the total amount used was closer to $2.3 billion (buying back 35.6 million shares at an average price of $64.46). So the remaining authorization to repurchase shares, which started at $10.6 billion, is now $8.3 billion for the next three quarters.
We should discount this number for three reasons: 1) potential dilution, 2) an ongoing repurchase program and 3) with caution in mind. As we just saw, the "net" amount of repurchases will not always equal the total amount used as a result of stock compensation. So instead of $8.6 billion, you might think in terms of say $7.5 billion.
Beyond that, it's possible that JPMorgan has already used more of this allowance - after all, management has not yet considered a special dividend and the buyback program is ongoing. Let's discount this to $6.5 billion. And just to remain cautious, let's again discount it to an even $5.4 billion - better to be pleasantly surprised instead of disappointed by something well within the realm of possibility.
If JPMorgan were to pay out $5.4 billion as a special dividend instead of using it for share repurchases, this would equate to a per share payment of roughly $1.50. Based on a price near $83.50, that equates to an "extra" yield of 1.8%. That's hardly an investment thesis, but it would be a fine boost for long-term shareholders who would prefer the cash funds as compared to the company buying out past partners at today's price.
Looking into the future things could get more interesting. Suppose shares continue to trade at an elevated level and the special dividend is used instead of share repurchases. Using the roughly $10 billion number, that's an "extra" ~$2.75 in cash payments that would be made each year - easily doubling the current payout and translating to a yield north of 5%. Interestingly, while this may appeal to the income investor, this situation could actually be a less appetizing scenario for the total return investor.
In short, shares of JPMorgan have increased materially this year and especially so as of late. The prospects for the business could very well be better than they were, but I would contend that the "investment bar" is now materially higher as well. JPMorgan CEO Jamie Dimon seems to mirror this thought and has laid out a rationale way to think about using funds for repurchases or special dividends.
If a special dividend is declared, it could very well add materially to one's income, but may or may not prove to be more impressive from a total return point of view. The more beneficial takeaway, in my view, is that ongoing or prospective shareholders have a management team that cares about allocating capital effectively for long-term owners.
Disclosure: I am/we are long JPM.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.