The ModernGraham approach to investing has multiple layers to it. Regular readers will be familiar with the first two steps; the first is to determine if the company is suitable for the Defensive Investor or the Enterprising Investor, and the second is to compare the price to the intrinsic value through quantitative analysis. The next step in the analysis is to review the company’s management and other qualitative factors to determine how the company may compare to other companies that pass the first two steps. In this Company of the Week series, we will delve into more detail about a specific company that performed well in the first two areas. This week, the company chosen, JP Morgan Chase, is currently significantly undervalued based on the ModernGraham valuation model.
Results of Recent Valuation
Please be sure to review ModernGraham’s latest valuation of JP Morgan Chase in detail, but here is also a summary:
JP Morgan Chase is suitable for either Defensive Investors or Enterprising Investors. The company passes all of the requirements of both investor types, which is a rare accomplishment. As a result, value investors following the ModernGraham approach based on Benjamin Graham’s methods should feel comfortable proceeding with further research into the company and comparing the company to other opportunities through the ModernGraham Valuation Index. From a valuation side of things, the company appears to be undervalued after growing its EPSmg (normalized earnings) from $2.92 in 2010 to an estimated $4.75 for 2014. This strong level of demonstrated growth outpaces the market’s implied estimate of only 1.49% earnings growth and leads the ModernGraham valuation model to return an estimate of intrinsic value that is well above the market price at this time.
Price trend compared to the market
In the following chart, it is clear the market has not viewed JP Morgan in a very favorable light. This is largely due to speculation regarding how recent litigation involving JP Morgan will work out and affect the company, but speculation does not drive the intrinsic value of a company. In JP Morgan’s case that means the price has been driven down, but the earnings continue to demonstrate strong value. Intelligent Investors know that the price trend has nothing to do with value, but this portion of an analysis can be useful in trying to understand Mr. Market’s movements.
Earnings Per Share
The next chart shows JP Morgan’s earnings over the last 25 years. At first glance, the reader will notice the wide swings in the chart, and a speculator would conclude the company is on another downward trend and end the analysis there. But it is important to see the overall trend in the earnings, which indicate an upward movement over time. Notice that even with the significant swings, it is easy to extrapolate an upward trajectory. This conclusion is supported further in an analysis of the average earnings, a measure on ModernGraham called EPSmg. JP Morgan has seen a rise in EPSmg from $2.51 in 2009 to an estimated $4.75 for 2014.
Price to Book
In another confirmation that JP Morgan would seem to be an excellent value at this point in time, the price to book ratio is well below where it has normally been seen in the last 25 years. As a result, it is possible we could see Mr. Market turn around and start pricing the company higher.
Dividend payments should be a critical part of any intelligent investment analysis. There is no better way to ensure a return on investment than through dividend income. With JP Morgan, it is clear the financial crisis had a significant effect on the company, as the company cut the dividend significantly during the crisis years. However, the dividend has since recovered, though the yield remains lower than it was during the period before the crisis. As a result, there appears to be some room for further growth in yield.
JP Morgan is a very intriguing company for both Defensive Investors and Enterprising Investors to consider. In addition, the quantitative analysis shows the company to be significantly undervalued. It is possible that Mr. Market has overreacted to any perceived troubles the company has had in the recent past, speculating that the company would be crippled by the regulatory litigation issues. However, as has been seen time and time again, large companies often have the resources to weather the ebbs and flows of business competition and that may be the case with Yahoo as well.
Warren Buffett has promoted looking at some key management tenets, and I’d like to leave it up to readers to discuss how JP Morgan fulfills (or fails to fulfill) these qualities. Please discuss the following in the comments below:
- Is the business simple and understandable?
- Does the business have a consistent operating history?
- Does the company have favorable long-term prospects?
- Is management rational?
- Is management candid with shareholders?
Disclosure: The author did not hold a position in any company mentioned in the article at the time of publication and had no intention of changing that position within the next 72 hours.