JPMorgan And Dimon's 'Golden Age Of Banking' - An Assessment

Summary

• JPM is trading 12% off its high but with record earnings recorded and growth projected.
• It is also at about a 1/3 discount to the forward market multiple.
• Yet JPM's CEO Jamie Dimon says a golden age of banking has arrived; is he right?
• This analysis reviews his thinking and concludes that he may be right: but only for his bank amongst its peers.
• The case is made that JPM deserves a higher relative multiple and probably a higher absolute multiple, as well.

Introduction - The case for a golden age of banking

One of the most interesting interviews with a corporate leader I have seen in some time was given by JPMorgan Chase's (NYSE:JPM) CEO, Jamie Dimon, on June 1. Per the Seeking Alpha transcript, the key and potentially actionable part of this telephone interview reads as follows:

Operator

Is there a bull case for the profitability of the banking industry over time, it just gets more efficient as you get more digitization - you know, fewer Brinks trucks driving cash around?

Jamie Dimon

You guys thought I was kidding when, years ago, I said you’re going to have a golden age of banking. I mean, you’re going to have a golden age of banking. You have a golden age of banking.

In the earlier part of the interview, and following this comment, Mr. Dimon goes on to provide some basic reasons why he has been saying this. Some of the reasons include:

• Industry consolidation in the US.
• High-tech nature of banking favors the biggest banks.
• Several recurring revenue streams.
• Improving regulatory regime.

It is important to understand that he is talking about a golden age for diversified financial institutions, not community banks that basically take deposits and make loans.

He puts this thesis in context of a mostly rosy scenario for the US economy, saying earlier in the interview:

... the world is going to hit an all-time low in unemployment sometime this year... even the perpetually worried IMF is talking about strong global growth.

Focusing on the US, he is ebullient about growth in the next year and beyond:

... the United States is the one where it’s been 2% a year for nine years [since the Great Recession], and kind of a cumulative 20%. But you’ve got to put that in perspective - while it’s been long, it’s slow. The average recovery is 40% in less of a time period, so there’s still slack in the system, people are still coming back into the workforce. You’re now starting to see inflation at 2%, wages go up 2.7%.

He then says some things that surprised me, because he has been identified as a Democrat and was considered for Treasury Secretary under President Obama:

I would look at it a little bit more like we’re probably in the sixth inning or something like that, and just it has taken a little bit longer, and mostly because of bad policy - bad tax policy, bad regulatory policy, bad policies, some of which are being fixed... you’re seeing increasing strength [in the US economy]... You see capital expenditures going up a little bit, consumer and business confidence are close to all-time highs. There are no potholes.

"There are no potholes," no 2007 scenario.

I like that a lot. The CEO of JPM would know if there are any, and he's definitive. Steady as she goes...

He went on to praise Trump's tax reform, saying that he just returned from an Asian trip, and manufacturers there believe that tax reform is (lightly edited for clarity):

... going to make it much tougher to compete with America, because at a 21% tax rate, that plant could be built in the US and you could export to Asia, as opposed to building it in Asia to export to Asia, or building it in Europe to export to Asia.

I found that very interesting. Even on the trade war issue, he agreed there are some legitimate issues, though he prefers a quieter, more modulated approach to resolving them.

JPM does about 80% of its business in the US, so a strong US economy with no potholes for bankers puts it in strong position to thrive even if there are some tariff wars. The US remains a tariff-free zone for internal trading.

With this extended introduction, the question is then raised for investors: should JPM and its few peers in multi-line financial services and traditional banking be afforded higher absolute P/E's, and/or higher relative P/E's to the S&P 500 (SPY)?

The case to re-rate the best universal banks higher

A universal bank such as JPM provides many financial services in addition to traditional lending. In JPM's case, it is the world's 3rd largest custodian of financial assets, I think headed for $25 trillion or so under custody when BlackRock (BLK) moves $1.5 trillion to JPM's custody.

This is a generally sticky revenue stream, and though it's at small margins, it provides a way to generate related revenues. JPM is also one of the world's leading investment bankers and asset/wealth managers. Done right, these functions connect with each other. And they all intersect with personal banking. Finally, in many ways, so does business banking, both for small-medium-sized businesses and for large corporations.

This universal or financial supermarket approach had been touted by Wells Fargo (WFC) for years pre-scandal as the reason for its superior financial results. But its various malfeasances do not negate the concept. It simply must be done honestly and intelligently. I had stayed away from JPM on principle after the London Whale fiasco, but I'm hopeful no major embarrassments surface now.

The universal banks suffered badly in the crisis a decade ago, but Wells Fargo and JPM appeared to be safe and sound. With the repeated scandals at WFC, though, only JPM remains standing with a strong reputation amongst the public and a strong track record of managing through one recession and stock market crash after another. Jamie Dimon points out that even in 2008, JPM earned a 7% return on tangible equity.

Other universal banks that came through the crisis well enough, such as U.S. Bancorp (USB), which I also am long, tend to be super-regionals or possibly regional banks. As large, systemically important financial institutions (SIFI's), they are subject to extra scrutiny, regulation and costs just as JPM is, but they lack the scale of JPM and the other members of the Big Four (BofA (BAC) and Citi (C) are the other two).

I can see why most regional banks and super-regionals would trade at a discount to the SPY. Banks are basically retailers of money that ultimately is provided by the private-public institution, the Federal Reserve. The smaller banks can earn some investment banking income bringing local businesses together in M&A activity. But this is highly competitive stuff, and at the end of the line, these companies do large amounts of borrowing short term and lending longer term, so there is lots of downside risk.

So I own USB just as another bond substitute, as it is trading at a significant discount to the SPY but is acknowledged to be an extremely well-run super-regional. And after going risk-on with BAC, I took profits this January as part of going risk-off. Remember, BAC was formed by the merger into a western super-regional of a failing mostly eastern super-regional.

It was never a complete, international universal bank. Citi was, but it has been weakened badly by its near-bankruptcy. And the old investment banks that had to change in a New York minute to commercial banks in the crisis a decade ago, notable Goldman Sachs (GS) and Morgan Stanley (MS) are weak in the general lending sphere. So they do not deserve a market P/E on normalized or mid-cycle earnings.

Thus I consider that only JPM of the US banks should be under prime reconsideration as a potential market peer. For a dominant financial institution that helps make all the rest of the economy smoothly, and as a DJIA (DIA) member, my interpretation of what Jamie Dimon really has been saying is that JPM is special enough to deserve a premium P/E.

His "golden age of banking" attempted meme may really just be a plea to differentiate JPM and give it the multiple he believes it deserves.

The case for a higher P/E for JPM

By far the most comprehensive case for JPM I have seen is the PowerPoint presentation it made up for this year's Investor Day. Even though it's a few months old, it's not stale.

This is lengthy and far too detailed to go into point by point (my preference, I happen to like the detail; GE (GE) misfired in the Immelt years in part by not paying attention to one detail after another). Happily, there are two summary pages I'll discuss next, but one particular point caught my eye. Namely, after three introductory slides, Slide 4 did not talk about earnings, stock price, resilience in the Great Recession or Mr. Dimon's famed "fortress balance sheet." What, you may ask, did it focus on?

The company's brands.

It spends a whole page of valuable, image-creating digital real estate - and not just digital - this accompanied a presentation by the CFO, I believe - explaining that JPM as a holistic brand was great, that the J.P. Morgan brand was great, and that the Chase brand was great.

I respect this focus, because what is a financial services supermarket but a collection of brands? They have the same regulator. They lend the same money at the same rates, and they pay the same to borrow money from depositors. The top investment banks charge about the same fees and all use the best lawyers and accountants to structure deals the best way. But somehow "Chase" is drawing millennials. Somehow JPM as a whole was #10 this year on Fortune's "most admired" company list. Since JPM's brands are hot, I definitely give the stock an extra P/E point, maybe two.

Now, the S&P website suggests that forward earnings for the SPY will be $156 for the 12 months ending 6/30/19 using GAAP and $166 using operating earnings. JPM is shown by E-Trade at a little more than 11X earnings. With the S&P 500 at 2727 as of Monday's close, and just using $160 as projected earnings, the SPY is at 17X forward earnings. JPM is trading at a 1/3 discount.

That suggests either that JPM's earnings are a good deal more vulnerable in a recession than those of the SPY or that it will grow a lot more slowly.

Yet its 10 and 15-year history shows healthy growth, in line with the economy and the SPY. And, it has just passed a test by the Fed showing that in a near-depression, with GDP dropping 7.5% and home prices crashing, it will survive. This sort of stress testing (CCAR) almost guarantees no recurrence of a banking crisis.

This in turn means that JPM's plans - approved by the Fed last week - to return $3.20 in dividends and up to $20 billion in buybacks to shareholders over the next 12 months is probably sustainable. It implies more than an 8% dividend or dividend-equivalent yield. Note, though, that a minority part of the buyback goes to sterilize stock-based compensation to insiders.

Because I believe these returns are sustainable and can be projected to grow at a rate roughly equal to nominal GDP, I find this a compelling argument that few other high quality stocks can match. So, that's one practical argument for a market P/E for JPM. It is buying back cheap stock while providing a 3+% dividend yield.

For investors looking to get to the core of the presentation from Investor Day, Slide 68 provides a boilerplate summary of JPM's core goals. Slide 70 makes the case that JPM is either best-in-class or close to it in all 4 of its segments. Arguably it is #1 in:

• consumer banking
• investment banking
• wealth management.

It used to be said that investment banks and brokerages were poor investments not because they were leveraged, but because their competitive advantage - their talent - went home every night. People could move around and take clients and business arrangements with them. There is something to that still, but this is where JPM's focus on branding comes in, along with its "fortress balance sheet" and general stature (mind-share, if you will). I think this large an array of leading market positions supports the idea that JPM may deserve a market multiple.

Moving to Slide 71, note the 17-35% projected return on equity, or ROE, for all 4 of its segments.

Finally, leaving the presentation behind, JPM is expanding its physical branch network to new areas of the US. It says that these are all highly profitable and that a large percent of its actual and potential new customers look at a physical bank branch as either key or important to the value proposition a bank brings. I agree with this. Correct me if I'm wrong, but I think that JPM is the only one of the Big 4 banks to be moving in this direction.

Intangibles: Management

In the final analysis, running a business turns on management. When the business involves mostly commodity-type products, as in banking, superior management is not going to be beaten by a surprise hit product from a company that is run less well, as can happen in tech. It would appear that the merger of JPM with Chase Manhattan went well, and JPM proved strong in the Great Recession as a result of that success and generally good lending practices. In contrast, look at the messes at C and BAC following their various mergers.

Since becoming CEO, Jamie Dimon has led the branding strategy, the successful digital strategy, fought off cancer (2014) and plans to remain CEO for 5 more years. So I trust that JPM will be a "steady as she goes" ship.

While the post-Great Recession new leadership at BAC and C have done good jobs, the structural weaknesses tell me that these particular stocks deserve discounts to the market and to JPM.

I think that JPM has been managed in an industry-leading manner relative to other US as well as the great majority of global mega-banks, and with stable management ahead, this is yet another reason to increase JPM's relative P/E.

Risks

These are almost too numerous to name. Scandal, recession, trade wars, Fed errors, etc., all can harm this stock.

Please see the company's disclosures of its risks in its 10-K and elsewhere for a full discussion of them.

Conclusions - JPM as a stock worth thinking about

One of the disparities I have observed in the market this year is that superior companies within an industry have frequently traded at the same P/E as laggards. I have mentioned Deere (DE) versus AGCO (AGCO) and Home Depot (HD) versus Lowe's (LOW), and I have frequently mentioned Apple (AAPL) versus many other tech names as examples of this phenomenon.

JPM strikes me as fitting into this paradigm. I think it is too cheap to other universal banks and too cheap to the SPY. Per Jamie Dimon's "golden age of banking," I propose that JPM's many strengths position it well to grow at least as fast as nominal GDP. I also propose that once again, it is well-positioned to gain durable market share if a recession supervenes. One thing I like about JPM and other category-dominators such as HD and DE is that with the Fed tightening, the greatest pressure is usually felt by the "wannabe" competitors.

With greater than an 8% capital return yield and about a 9% earnings yield (reciprocal of the P/E) on 12-month forward projected EPS close to $9.50 through 6/30/19, JPM may appeal to both dividend and GARP (growth at a reasonable price) investors.

Risks are significant.

Thanks for reading and sharing any comments you wish to contribute.

Disclosure: I am/we are long JPM, USB, MS, DE, HD, AAPL, GE. 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.