A 'Compelling' Case for JPMorgan's Stock

NEW YORK (TheStreet) -- Some investors were disappointed with JPMorgan Chase's (JPM) outlook during the company's Investor Day on Feb. 25, but an important element in the numbers may have been overlooked.

For starters, JPMorgan said its long-term goals included a return on tangible common equity ranging from 15% to 16%, which was a slight decline from the 16% goal stated a year earlier. The company also said it expected its core annual earnings to grow to roughly $27 billion over the next four years, from core earnings of $23 billion during 2013.

The bank's actual earnings for 2013 came to $17.9 billion, or $4.35 a share, declining from $21.3 billion, or $5.20 a share in 2012. The 2013 results were lowered by $11.1 billion in legal expenses, rising from $5.0 billion the previous year.

The $27 billion goal for annual core earnings equates to $7.10 a share, based on JPMorgan's current share count, according to Bank of America Merrill Lynch Erica Najarian.

"We're at $7.00 in 2016 with no short rate increase built in, so we can see why this would be disappointing," Najarian wrote in a note to clients on Thursday.

Not only was an expected rise in short-term interest rates left out of JPMorgan's projection, the company made no assumptions about lowering its share count through buybacks, which was wise, considering that the company hasn't been able to make share repurchases close to the amounts it has planned to make, over the past two years, because of the "London Whale" hedge trading debacle in 2012 and the hefty array of mortgage and other legal settlements during 2013.

But JPMorgan's regulatory and legal mess, springing in great part from its acquisitions of Bear Stearns and Washington Mutual in 2008, won't last forever.

According to Najarian, JPMorgan's projections also excluded "loan growth or fee growth in a continued economic recovery."

So there are plenty of moving parts that could support higher-than-expected earnings over the next several years, as well as a significant lowering of the share count, which will push EPS higher.

"[O]ur own bottoms up analysis (conservatively) suggests $29bn in "normal" net income - compelling, considering the current market cap of $220bn. This is $7.75 in EPS on the current share count, and $9.00 if we assume JPM can shrink its share count (net of issuances) by 15% over the next 4 years," Najarian wrote.

Like the rest of the "big four" club of U.S. banks, including Bank of America (BAC), Citigroup (C) and Wells Fargo (WFC), JPMorgan is asset sensitive, meaning its balance sheet is positioned so that its assets will reprice faster than its liabilities when short-term and long-term interest rates rise.

Long-term interest rates rose during 2013, as investors anticipated the Federal Reserve's eventual tapering of "QE3" bond purchases, announced in December. Fed Chairwoman Janet Yellen has said she expects the Fed to complete winding down the bond purchases by the end of 2014.

But the Fed continues to keep the short-term federal funds rate in a historically low range of zero to 0.25%. Continued repricing of assets indexed to short-term rates narrowed net interest margins for all of the "big four" banks except for Bank of America during 2013.

JPMorgan said in its annual 10-K filing on Feb. 20 that in the scenario of a 100 basis-point rise in long-term and short-term interest rates, its annual net interest income would increase by $2.518 billion, or 5.8% of its 2013 net interest income of $43.319 billion.

"In our view, the market often underestimates JPM's potential upside to rising rates and improving loan growth - focusing instead on volatile [investment banking] (6% of revenues) and trading (20% of revenues) and overlooking spread income (44% of revenues)," Najarian wrote.

Bank of America Merrill Lynch rates JPMorgan Chase a "buy," with a price target of $68, implying 16% upside over the next 12 months from Wednesday's closing price of $58.16.

Even without an increase in short-term rates, Najarian thinks JPMorgan can achieve EPS of $7.00 by 2016. "As such, at $58, in our view JPM appears undervalued on current EPS power."

Among large-cap U.S. banks, JPMorgan Chase is one of the cheapest, based on a multiple of 9.2 times the consensus 2015 earnings estimate of $6.35 a share, among analysts polled by Thomson Reuters. Only Citigroup trades cheaper than that, with shares closing Wednesday at $49.42, or 8.6 times the consensus 2015 EPS estimate of $5.73. And Citi's ROTCE has been much lower than JPMorgan's over the past several years.

JPMorgan's shares were up over 1% in early trading Thursday, to $58.79.

This chart shows the performance of JPMorgan's stock against the KBW Bank Index (I:BKX) and the S&P 500 since the end of 2011.

JPM Chart data by YCharts

Citigroup EPS Estimates Cut Significantly

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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