Valuentum Exclusive Analysis for the Discerning Investor

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J.P. Morgan has a major advantage when it comes to crown jewel consumer banking. The company is a powerhouse.

By Matthew Warren

J.P. Morgan (JPM) reported first quarter earnings of $2.65 per share, fully 30 cents per share ahead of Wall Street estimates, and well ahead of $2.37 in the strong year-ago quarter. Managed revenue was up $1.3 billion over last year’s first quarter to $29.9 billion. Return on equity was 16% in the quarter versus 15% last year and return on tangible common equity was 19%--just as in last year’s quarters. These return on capital metrics, if broadly sustainable, fully justify the firm’s shares trading at 1.5 times book and 1.9 times tangible book equity. Capital levels are very strong with a common equity tier 1 ratio of 12.1%, despite the bank paying out 93% of earnings over the last 12 months, highlighting the lack of reinvestment required to support these impressive fundamentals.

Lest we not forget that banks are cyclical and have enjoyed a decade of mostly benign credit conditions following the Great Financial Crisis. When the next downturn eventually begins, revenues and therefore efficiency ratios will come under pressure, as will net charge offs, all of which will drag on earnings. That said, this bank has impressive earnings power, a strong balance sheet, solid efficiency ratings, low cost of funds, and ample liquidity, all of which suggests this bank is capable of withstanding the next downturn when it does come.

One main point that one should think about when considering J.P. Morgan is that its Consumer and Community bank is an absolute crown jewel with a 30% return on equity in the quarter. Consumer banking is most definitely a business that benefits from scale in this age of increasing digitalization. J.P. Morgan is talking about $11.5 billion of technology spend a year with half spent on improving the bank and the other half maintaining the bank, better than the 60% maintaining the bank last year. Fifty percent of $11.5 billion or $5.75 billion is more than the total expense line of thousands of banks in the United States, and the bank expects to be able to keep this spending flat even as revenues grow.

Smaller banks cannot afford to spend on digitalization in the same way that J.P. Morgan and the other large banks such as Bank of America (BAC) and Wells Fargo (WFC) can. Smaller banks have inferior websites and mobile apps, increasing the difficulty in walking down the cost efficiency curve resulting from digitalization of processes. This is a major advantage for the big banks when it comes to consumer banking, the reason why they have so much market share and why the thousands of smaller US banks will continue to be market share donors in years to come. J.P. Morgan is a powerhouse, but then that is reflected in the share price, which was up another nearly 5% on Friday following the earnings report. Our fair value estimate is $104, and the shares closed at $111.21 on Friday, April 12.

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Matthew Warren does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.