By looking only at the stock charts, investors would be forgiven for thinking that major banks were former high-flying technology companies. The sharp declines in shares of JPMorgan (JPM) (-33%), Bank of America (BAC) (-31%), Wells Fargo & Company (WFC) (-28%) and Citigroup (C) (-25%) since peaking last November actually exceed the plunge in the Nasdaq Composite (-26%). What is going on here, and are big bank stocks attractive now, or should they be avoided?
Part of the decline in major bank stocks is driven by the removal of their formerly high valuations. JPMorgan (JPM) and Bank of America (BAC) sold at sizeable multiples – as much as 2.5x their tangible book values. We often use this valuation metric, price/tangible book value, because most assets and liabilities of banks are recorded on the balance sheet at their approximate market value. By netting assets and liabilities, and removing intangible assets like goodwill, we get a rough estimate of a bank’s market value. A useful rule of thumb is that a reasonably healthy bank in a normal environment will trade at roughly 1.0x tangible book value.
Healthy mega-banks may trade at much higher valuations if conditions are favorable. Last year, these banks generated reasonable profits from lending (as measured by their net interest margins), strong profits from fee-based activities like merger and acquisition advice and securities trading, and had minimal credit losses. The economy was booming and interest rates were low.
But, today, conditions are not nearly as favorable. Profits from lending may be squeezed by higher interest rates. Deal activity is sharply lower due to volatile capital markets. Investors worry about the prospects for weak lending and higher credit losses if the economy slips into a recession. Profits from securities trading will likely be stronger, but these profits are less predictable and earn lower valuation multiples than more resilient lending and deal profits.
Also, even though the banks passed the recent Federal Reserve stress tests, some are now restricted in their ability to raise dividends and repurchase shares. These new constraints contrast with high enthusiasm late last year about the possibility of large share buybacks and higher dividends.
All-in, investors appear to have abandoned big bank stocks. We think these banks are more attractive now and worthy of new investment, with JPMorgan as a top choice.
JPM: My Favorite Big Bank Stock
Shares of JPMorgan have slipped by a third (33%) from their high last November, and now trade nearly 20% below their pre-pandemic year-end 2019 price. Even more surprising, they trade only about 40% above their March 2020 price in the depths of the pandemic. At the time, investors sold shares in a panic – it would seem unlikely that JPMorgan’s future could darken enough to approach that price again.
Yet, compared to its 2019 results, the bank is generating higher profits and has a stronger capital base. As outlined at its recent Investor Day, the first in three years, JPMorgan continues to advance its already impressive growth, profitability and technology initiatives to further develop and expand its franchise, which extends from retail banking to raising capital for businesses to the inner workings of the financial system. JPMorgan’s initiatives and financial strength are backed by its strong profitability and capital generation. Led by Jamie Dimon, perhaps the most disciplined and capable CEO in corporate America, the bank looks well positioned to prosper for years to come. While the Federal Reserve stress tests showed that JPMorgan will need to limit its dividend increases and share buybacks in the near term, the current dividend looks solid and the incremental capital would be necessary only in dire economic conditions.
The shares trade at a 1.6x price/tangible book value and 10.0x estimated 2022 earnings – both quite reasonable given the bank’s quality. Maintaining the dividend is a top capital allocation priority and the shares pay an attractive 3.5% dividend yield.
All-in, JPMorgan’s high quality and low valuation make it a highly appealing big bank stock.
At the Cabot Turnaround Letter and Cabot Undervalued Stocks Advisor, we help investors navigate the equity markets using a common sense value-oriented approach that emphasizes out-of-favor stocks of companies with real value. Let us help you sort through the market to find them.
Do you still own any big bank stocks in your portfolio? Tell us how they’ve performed in the comments below.