Summary
JPMorgan Chase is a high-quality bank as evidenced by its superior risk-adjusted return on equity.
JPM stock’s current valuation is in line with history.
JPM has liquidity, capital, and earnings power.
JPM aligns well to my investor risk profile.
Accumulating JPM in my long-term buy-and-hold bank portfolio even if the bank slows buybacks or interest rates do not increase.
LewisTsePuiLung/iStock Editorial via Getty Images Article Organization
Investor Risk Profile
Bank Valuations
Low-Quality vs. High-Quality Banks
JPM: Valuation, Profitability
Bank Subsidiary: Liquidity/Cash, Core Deposits, Loans
Risks
Closing Thoughts
Investor Risk Profile
I tend to be a conservative, long-term buy-and-hold bank investor.
It is not difficult to find “cheap” banks, that is, banks with bargain basement valuations. I like cheap, but given my risk profile, I like earnings quality even more. Therefore, given a choice between a cheap bank with low earnings quality and a more expensive with higher earnings quality, I take the latter every time.
I plan to show in this article that JPMorgan Chase & Co. ( JPM ) is a “high-quality” bank. And though not cheap, as a long-term investor, I believe JPM’s shares are reasonably priced for accumulation.
Before discussing JPM, it is necessary to define two terms used throughout this article: Graham Multiple and Risk-Adjusted Return on Equity (RAROE). Bank Valuations: Graham Multiple & RAROE Graham Multiple In my 2016 book about banking investing, I introduced investors to the term, “Graham Multiple.” I have periodically referred to this metric in Seeking Alpha articles.”Graham Multiple” may be unfamiliar to readers. The concept behind it is simple. It is a variation on a metric Benjamin Graham described and used in his book, The Intelligent Investor . Graham was a Columbia University professor who developed a life-long mentoring relationship with Warren Buffett.Graham emphasized the merit of value investing. His definition of value related to the price of an investment compared to its inherent worth. To understand the relative value of an investment over time, Graham used the traditional metrics of price-to-earnings (P/E) and price-to-book value (P/B).Graham believed that “intelligent investors” should seek a “margin of safety” when investing in a company. To avoid overpaying, Graham devised an ingeniously simple metric that I call the “Graham Multiple.” (Graham did not use this term.)The Graham Multiple is the product of a company’s P/E times its P/B. Graham urged investors to avoid investing in companies where the multiple exceeded 22.5.Back in the 1930s to early 1970s when Graham was investing, few companies approached a 22.5 Graham Multiple. Today, few do not.For banks, an investment sector Graham did not address in any depth in his writing, I have determined that it is necessary to tweak Graham’s metric. My research shows that bank investors should measure price-to-earnings and price to tangible book value (P/TBV) instead of price to book.Therefore, my preferred Graham Multiple for banks is P/E times P/TBV (P/E*P/TBV). Risk-Adjusted Return on Equity (RAROE) In my 2016 book, I introduced bank investors to another term not common to the lexicon of investing, “RAROE.”RAROE is the acronym for “Risk-Adjusted Return on Equity.”My research shows that there is a statistical relationship between a bank’s Return on Equity (ROE) over time and its valuation.The RAROE metric reflects the reliability of a bank’s returns over time. To calculate RAROE: Determine the bank’s average quarterly ROE over time minus the standard deviation of the ROE for the same timeframe.Banks that consistently and reliably produce returns on equity exceeding cost of capital tend to have greater valuations (i.e., higher Graham Multiples) than banks that produce unreliable returns on equity. (Other factors influence valuation as well, but that is a subject for another day.)High-quality banks have superior RAROEs; they reliably generate quarterly earnings that exceed the cost of capital. Low-quality banks have low RAROEs; their quarterly profits frequently fail to cover the cost of capital. RAROE and Graham Multiples for Six Large Banks The scatterplot below examines the five-year RAROE and 12/31/2021 Graham Multiple for fifty-nine banks that have publicly traded for 40 years.The x-axis of the scatterplot shows each bank’s five-year risk-adjusted return on equity (RAROE). The y-axis shows each bank’s current “Graham Multiple.”The six banks highlighted in gray boxes are six large banks. Note how closely each bank’s current Graham Multiple aligns to its respective 5-year risk-adjusted returns on equity. (The same holds true for longer term RAROEs, but there is a “decay” factor over time. Again, another subject for another day.) Low-Quality vs. High-Quality Banks Citigroup To understand JPM, it is helpful to contrast it to Citigroup Inc. […]
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