I Hate Banks but I love JP Morgan

Contrarian investing is, in concept, one of the simplest things in the world.  It says that the masses are idiots and are always wrong; therefore, doing exactly the opposite of the masses is the correct thing to do.

The problem with contrarian investing is that the masses are sometimes right.

In 1985, faced with high interest rates, the masses said that interest rates could still go higher (and long-term bond prices lower)  – and they were right.  In 2009, despite falling markets and great valuations, the masses said that stocks would still go lower – and they were right.  Doing the opposite of what the crowd recommends isn’t always the best course of action.

And yet, contrarian investing works, largely because people make investment decisions based on emotions rather than logic.  Case in point: CEO Jamie Dimon's annual newsletter, released Wednesday.

In the newsletter, Dimon pointed out that JP Morgan Chase had record earnings of $19 billion last year (that’s the best year ever).  He added that the earnings would have been even better if it had not been for still-high mortgage related losses.  As time has gone forward, these losses have been declining.

Most interestingly, Dimon hinted that the price of JP Morgan stock was likely low because of “hostility” toward him and to the banking sector in general.  Based on the comments seen after the newsletter was released, Dimon is right: he was called a “criminal,” “manipulator,” “slime ball,” etc.

By now, I’m sure Dimon is immune to such disparaging remarks.  As a banker myself, I occasionally have clients tell me that they “hate banks,” which I consider a polite (weak?) way of saying, “I hate you.”  Then again, I also have people tell me that I’m wonderful but that they hate bankers: is that a compliment or an insult??

Emotions aside, here are the facts that investors should be interested in:

-         Record earnings of $17 billion, up from $12 billion in 2009.

-         Return on equity of 15% (which Dimon thought was low).

-         Market share growth in almost every area.

-         Approved to implement stock buybacks.

-         Opening 120 to 200 new branches a year.

There are many headwinds in banking, to be sure, including new regulations, housing weakness, and worldwide economic uncertainly.  But none of these are reasons to not buy a company.

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“We all have a vested interest in getting this right.”

Jamie Dimon

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US Banks to Rumble

I’ve been recommending US bank stocks for over a year now – after all, they are powerhouses of future potential. Though bank stocks have risen slightly in the past year (about 15%) there is still far more room to move. And, things are about to get hotter.

Last week, the US Federal Reserve approved buybacks and dividend increases for many of the major banks. JP Morgan, for example, is repurchasing approx. $15 billion worth of shares, having already repurchased $7 billion last year. Wells Fargo jumped its intended share buyback program from $1 billion to $6 billion. What is the significance?

Share buybacks reduce the number of shares outstanding, increasing the amount of earnings per share. For example, if you buy 100 shares today, and the company buys back 30% of its shares, you effectively own 130 shares’ worth of former value. Put another way, if there are $0.50 of earning per share now, a 30% share repurchase would give you $0.65 of earnings per share. Buybacks compound the value of your purchase.

Most banks will be buying back their shares as a mix of common and Trust Preferred Securites (TruPs), the latter of which is really a kind of debt. The common share repurchases will affect earnings per share directly, while the TruP repurchases will effectively decrease debt load and interest payments – all good things.

Stunningly (and wonderfully), despite announcing these huge stock buybacks, bank stocks have traded flat for a week! Why, you may ask?

First off, people still have an intense mistrust of US banks. Stated more bluntly, most people either fear or despise banks, and wouldn't go near them as an investment. For the rational, thoughtful investor, this is a good thing. Bank stocks are likely to remain underpriced for some time.

People also worry that the world economy is unstable, and that the banks will be spending too much money on their stock repurchases instead of holding the money for emergencies. Make no mistake… no bank wants a repeat of 2008 any time soon. Banks are repurchasing their stocks because said stocks are grossly underpriced, and because they can. The banks are sitting on hordes of cash.

Stock symbol XLF (US bank index fund), provides a great way to buy US Bank stocks with a small amount of cash. For the risk tolerant, UYG (the 2X movement stock index fund) is also available.

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"Superior risk management positioned JPMorgan to capitalize on the crisis."

Barbara Rehm, editor, American Banker

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Disclosure

Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

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