JPMorgan Chase: Too Big To Fail Financial Utilities

Jan. 07, 2020 1:20 PM ETJPMorgan Chase & Co. (JPM)BAC, BCS, BK, C, CS, DB, GS, MS, STT, UBS, WFC5 Comments13 Likes
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Praveen_Chawla
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Summary

  • Buffett in a CNBC interview last February said that given long-term bonds, JPM stock is cheap at <2X tangible book value and should be trading at more than 3X.
  • Since the interview, 10-year interest rates have gone down from 2.67% to 1.8%, a decline of 32% and JPM stock has gone up over 30%.
  • Buffett has famously said that interest rates are like gravity on stock valuation. Given low interest rates for the foreseeable future, the big banks will continue to generate great results.

Background & Investment Thesis

Barron's Andrew Bary points out that In a CNBC interview in February, Buffett suggested that JPMorgan Chase (NYSE:JPM) ought to trade for at least three times tangible book value, which at the time of his comments would have implied a price of about $168, against a market price then of about $105. Buffett explained his thinking as follows.

"A business that earns 15% or 16% or 17% on net tangible equity, that's incredible in a world of 3% bonds. I mean, just imagine that you had a deposit account with JPMorgan that they made a mistake and they gave you 15% on it. And they couldn't redeem it. What would you sell that account for? You wouldn't sell it for 100 cents on the dollar. You wouldn't sell it for 200 cents on the dollar. You wouldn't even sell it for 300 cents on the dollar, You have an FDIC-guaranteed instrument that would now be at 300 cents on the dollar. If it was 15% on equity, you'd be earning 5% on it, which is way better than Treasuries. Now, if on top of that, your deposit allows you to let your interest compound to some extent, now, that instrument becomes even worth way more. Because if you have an instrument that could compound at 15% for 10 years and use the added capital, that's worth way more than three times tangible equity at current interest rates, way more."

The bank's return on tangible equity is 16% based on trailing twelve months. JPMorgan's tangible book value (TBV) is $58.32 a share, implying that it should trade to $174.96 based on Buffett's 3x TBV.

Based on the Buffet's logic, I took a look at the other systemically important financial institutions (SIFIs), colloquially known as Too Big to Fail Banks in the table below.

Company Name Symbol Current Price ROA % ROE % Return-on-Tangible-Equity ROE % Adjusted to Book Value Forward PE Ratio Price-to-Tangible-Book PE Ratio Dividend Yield %
Bank of New York Mellon Corp (BK) 50.27 1.07 8.97 19.43 7.29 11.83 2.99 13.02 2.35
JPMorgan Chase & Co (JPM) 138.34 1.3 12.74 16.06 6.92 12.97 2.37 13.66 2.46
Wells Fargo & Co (WFC) 53.42 1.19 10.71 13.6 8.05 12.18 1.72 11.54 3.59
Bank of America Corp (BAC) 34.9 1.17 9.85 13.28 7.64 11.72 1.8 12.93 1.89
State Street Corporation (STT) 79.57 0.89 7.67 12.19 5.72 12.44 2.42 15.73 2.49
Morgan Stanley (MS) 51.2 0.95 9.64 10.86 8.53 9.76 1.29 10.92 2.54
Citigroup Inc (C) 79.7 0.96 8.86 10.28 9.04 9.44 1.16 10.58 2.41
Goldman Sachs Group Inc (GS) 231.58 0.95 9.44 9.9 9.25 9.61 1.09 10.36 1.79
UBS Group AG (UBS) 12.71 0.41 7.3 8.32 9.01 10.08 0.91 11.05 5.4
Credit Suisse Group AG (CS) 13.48 0.36 6.44 7.27 8.94 8.74 0.81 12.07 1.91
Barclays PLC (BCS) 9.51 0.13 2.72 3.11 5.67 7.59 0.54 18.3 3.73
Deutsche Bank AG (DB) 8.12 -0.3 -6.75 -7.76 -28.13 0 0.27 0 0

Commentary

Chart 1 - 10 year Treasury and TIPs Yield.

JPM is currently trading at ~$138. Since the interview on February 25, 2019, 10-Year Treasury yields have fallen further from 2.67% to 1.8%. After inflation rates are close to zero. In spite of this, JPM is earning record profits. This shows that these big banks have so much more going for them than, "net interest margins". Most of their money is made by just conveying money around in the economy, like an electric or water utility conveying electricity or water. They are collectively indispensable to the financial functioning of the nation and indeed most of the world.

JPMorgan, clearly, is among the most profitable of the big banks. Bank of New York Mellon (BK) has the highest Return of Tangible Equity but is also the most expensive on Price to Tangible Book basis. Morgan Stanley, Citigroup, and Goldman Sachs also look good value given that they trade close to tangible book value and are returning Return of Tangible Equity of nearly 10%. This means they are in a great position to return capital to shareholders via buybacks and dividends. Given that these banks are closely regulated by the Fed following the Financial Crisis. The Swiss banks UBS Group and Credit Suisse also look good selling below tangible book value while supporting a ROTE of 8%+. UBS sports a dividend of 5.4%. In fact, all the SIFI banks look like excellent investments given the practically zero returns (after inflation) from long-term bonds. The government has the SIFI's on a tight regulatory leash for now, while the memories of the financial crisis are still fresh. I doubt we will see significant deregulation until the boomers and Generation X have fully passed the baton on to the millennials. Till then, I believe SIFIs are like basically heavily regulated financial utilities generating low risk returns for investors that deserve a higher multiple to tangible book value. It's interesting to see that none of the SIFI banks are trading at Buffett benchmark of 3X TBV.

This article was written by

Praveen_Chawla profile picture
1.63K Followers
Pharmacist, MBA. Full time Investor. Early retired. Worked in the pharmaceutical industry most of my life. Learnt investing by making mistakes. Eight figure portfolio with double digit returns over 20 years.
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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.

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