THE HEDGEYE EDGE
JPMorgan shares are currently trading with the most implied upside to fair value in our fair value model for money-center, super-regional and regional bank stocks. By our estimates, JPM shares have upside of 33% based on our regression of EVA (economic value added) – which looks at the spread between return on capital and cost of capital – and the current multiple to tangible book value. Over time, we have found that sizeable discounts and premiums mean revert toward fair value giving JPMorgan an embedded tailwind in 2014.
From a catalyst standpoint, we expect JPMorgan to be quieter in 2014 than in 2H12-2013. This should be good news. Beginning in April 2012, when the “London Whale” fiasco first surfaced, and running through year-end 2013 it has been a rare day when JPMorgan or its CEO Jamie Dimon hasn’t been on page 1 in an unenviable light. This amounts not just to bad PR. JPMorgan recognized $11.1 billion in total litigation expense and existing reserve draw-down in 2013 – the highest annual amount in its history, and almost double the prior peak. For comparison, Bank of America (BAC) saw its peak litigation year in 2011, and went on to see its shares rise 108% in value over the following year and shares are now trading ~197% vs. year-end 2011.
INTERMEDIATE TERM (TREND) (the next 3 months or more)
In the intermediate term we expect the slow but steady improvement in the economy to continue to exert upward pressure on the long end of the yield curve. Widening yield spreads will fuel a modest acceleration in top-line growth for JPMorgan. Higher net interest income is pure margin as it requires no additional expense.
LONG-TERM (TAIL) (the next 3 years or less)
Our longer-term expectation is that JPMorgan will finally get past its “annus horribilis” (horrible year) of 2013 and begin to again move in the right direction. As the news flow and litigation expense of settlements begins to marginally decline, the discount to fair value will reflate. Moreover, the company, as of 4Q13, has finally achieved 9.5% Basel III “fully-loaded” capital, which is the amount required under the new regulatory framework.
What this means is that finally the company can begin requesting permission from the Fed through the CCAR process to return larger amounts of internally-generated capital to shareholders through stepped up dividends and increased share buybacks. Over the coming 12-24 months this will add to the return potential already embedded in the company’s significant relative undervaluation.