It’s Hard To Go Bankrupt If You Keep Generating Profits
There was certainly a lot of fear out there, but JPMorgan as an ongoing concern remained steady. And just as importantly, if the company can still generate profits in the worst of times, it gives you an idea of what’s possible for better times.
Later on in the shareholder letter Jamie Dimon added the following information related to the Comprehensive Capital Analysis and Review (CCAR) that is performed each year:
“The capital we have to bear losses is enormous. We have an extraordinary amount of capital to sustain us in the event of losses. It is instructive to compare assumed extreme losses against how much capital we have for this purpose.”
“JPMorgan Chase alone has enough loss absorbing resources to bear all the losses, assumed by CCAR, of the 31 largest banks in the United States. Because of regulations and higher capital, large banks in the United States are far stronger. And even if any one bank might fail, in my opinion, there is virtually no chance of a domino effect. Our shareholders should understand that while large banks do significant business with each other, they do not directly extend much credit to one other. And when they trade derivatives, they mark-to-market and post collateral to each other every day.”
In my view, and clearly in the view of Jamie Dimon, JPMorgan has emerged to be a much stronger company. Now let’s think about the security specifically, keeping the above information in mind.
In the following sections I’d like to talk about five basic areas:
1. Earnings growth
2. The dividend
3. Share repurchases
4. Valuation
5. What remains after dividends and share repurchases
In doing so I’m going to be making some assumptions. The goal is to come with a reasonable (perhaps cautious) set of assumptions and see what that could mean for today’s owner or prospective owner. It should be underscored that this is merely a baseline and not an absolute.
Past Earnings Growth
Here’s a look at JPMorgan’s business and investment growth from the end of 2005 through 2015:
I won’t work through everything, but I would like to highlight a few items.
The first thing that you might notice is that company-wide earnings growth was rather solid coming in at nearly 9% per year.
The share count increased a bit during this time (from about 3.5 billion to 3.7 billion) but this was much less than many other banks during the recession. Overall investors would have seen their underlying earnings claim increase by about 7.4% during the last decade.
That’s notable in my book. Here you had the worst financial crisis we’ve ever seen, and yet the bank was still able to provide very solid results over the long-term. Incidentally, if this sort of exercise does not pave the way for thinking in years instead of days, I’m not sure what will.
The valuation that investors were willing to pay for shares declined a bit during the period – from 13 down to 11 – so the share price growth trailed the annual EPS growth a bit. The dividend still grew, but not quite as fast as the earnings. Thus you have a payout ratio that actually decreased during the time.
Put together an investor would have seen total gains on the magnitude of 7% per year. As a point of reference, that’s the sort of thing that would turn a $10,000 starting investment into about $19,500 ten years later.
That’s what happened with the security in the past, which can be a useful baseline moving forward.
Future Earnings Growth
Naturally this part is unknown, but we do have some information. Analyst estimates for future intermediate-term growth have been in the 6% to 7% range. Let’s use 6% as our baseline.
Should JPMorgan Chase & Co. (NYSE:JPM) be able to increase its earnings-per-share by 6% annually, after a decade you would anticipate the company to be earning $10.75 or so. We’ll leave that part for now and move on to the next step.
The Dividend
What’s interesting about JPMorgan is that the payout ratio is lower, but so is the valuation. So you have a dividend yield that is basically in line with what it had been pre-crisis.
At present (including Q1 2016 results) the company is earning $5.90 per share and paying out $0.44 per quarter, or $1.76 on an annual basis. This represents a payout ratio of about 30%. At the very least you would anticipate future dividend growth to be in line with earnings-per-share growth. Yet this could be even greater.
If the company were able to increase its payout ratio to say 35% – not unreasonable considering the past mark and what other banks have been doing – this would imply a future dividend payment of about $3.75 after 10 years.
The dividend growth rate would be nearly 8% without paying out much more than a third of overall earnings. In total an investor might anticipate collecting $27 or so in per share dividend payments during the next decade. Much like the EPS number, we’ll leave it there for the moment and work toward the next step.
