The U.S. banking industry, after three consecutive years of very challenging market conditions, is likely to have a far better year in 2011. The largest banks, Bank of America (BAC - Free Bank of America Stock Report), Citigroup (C), JPMorgan Chase (JPM - Free JPMorgan Chase Stock Report), and Wells Fargo (WFC), are likely to post year-over-year gains. However, just as some banks weathered the difficulties of 2008-2010 better than others, so some banks will benefit from improved conditions faster than others.
Comparing the Value Line pages of Bank of America and JPMorgan Chase can show how the investment merits of two of the country’s largest banks differ, and what kind of investor might be attracted to which stock.
Comparing the Graphs of the two companies shows that JPM’s price has recovered to within about 10% of its pre-recession highs, while BAC’s continues at wallow at around a quarter of its 2006 high. A quick look at other parts of the page helps to explain this divergent price action. The historical portion of the Statistical Array shows that, although JPMorgan’s earnings per share dropped sharply, especially in 2008, the banking giant never registered an annual loss. Bank of America, on the other hand, has registered share-net losses both of the last two years and five of the last nine quarters (which can be seen by looking at the Quarterly Earnings box on the lower right hand part of the page).
Additionally, though both companies sharply cut their dividends, JPMorgan cut theirs to 13% of its former level, while Bank of America slashed its even more drastically, to the nominal level of less than 2% of its prior payout. Moreover, as Value Line analyst Theresa Brophy notes in the Analyst Comment and in her earnings update that JPMorgan is likely to be one of the first major U.S. banks to get permission from regulators to raise its dividend.
Finally, Brophy estimates that JPMorgan’s share earnings will rise to pre-recession levels in 2011, and register healthy growth over the coming three to five years (estimates and projections can be seen in bold italics on the right side of the Statistical Array). Bank of America, meanwhile, will struggle to reach half of its prior record 2006 per-share profit level ($4.59) by mid-decade (Brophy projects it will earn $2.35 by then).
Investors looking to get a sense of these stocks’ investment merits would be wise to dig beyond earnings and dividends, however. Value Line readers should note that the Statistical Array for banking industry stocks is different from that of standard industrial companies. The banking array records historical and estimated totals for such things as Total Assets, Loans, Net Interest Income, and so on, that are particular to banks. One metric that is particularly important is Return on Total Assets, which is something like a net profit margin for banks.
Looking at the historical Return on Total Assets figures together with stock prices for JPM and BAC is illuminating. In the mid-2000 decade, Bank of America’s Return on Total Assets figure was higher than JPMorgan’s. In that same time period, BAC stock tended to trade at roughly a 10%-18% premium to JPM shares. This shifted in 2007, at just the time that JPM stock price converged with that of BAC, and since 2009, JPMorgan’s Return on Total Assets figure has been much higher than Bank of America’s. Not surprisingly, its stock price has far outperformed BAC’s as well.
Another important metric is nonperforming assets. These are reported on a quarterly basis in the Business Description. By this measure, Bank of America again compares badly to JPMorgan: the former’s nonperforming asset percentage of 5.84% is well more than two and a half times as great as the latter’s percentage (2.14%).
Putting all these factors together, it should surprise few readers that JPM’s Timeliness ranking (a proprietary Value Line score) is 2 (Above Average), while BAC’s is 5, or Lowest (Timeliness, together with Safety, Technical, and Beta scores can be found in the Ranks box at the top left of the page). It may surprise readers, however, to learn that the two stocks’ projected price appreciation percentages over the coming three to five years are almost identical. These can be found in the Projections box to the left of the graph and represented visually by the dotted lines to the right side in the graph.
Once again, investors are best served by delving into the detailed information available in the Value Line page’s Statistical Array. There, we note two important things. First, Bank of America’s Return on Total Assets, which we showed above closely correlated with relative price performance for banks, is projected to come close to matching JPMorgan’s by 2013-2015. This suggests that BAC current stock price, which is about a third of JPM’s, may be low given the longer-term recovery potential implied by its (conservative) Return on Total Assets projections.
Second, we note from the Business Description that JPMorgan’s income was historically far less reliant on interest income than Bank of America’s; net interest income and noninterest income are both recorded on the Statistical Array. BAC’s net interest income has generally been about equal to its noninterest income. It has been significantly lower in recent years, largely due to very low interest rates. This is a situation that is likely to change in the coming years. JPMorgan’s income, on the other hand, was more diverse because it had a large investment banking division. The historical portion of the array shows that noninterest income was often close to double that of net interest income in the mid-2000 decade. But as analyst Theresa Brophy notes in the Analyst Comment, JPM faces increasing competition from investment banking firms, which are recovering quickly from the recession, and possibly from middle market firms expanding market share and/or new entrants in the sector.
In sum then, BAC’s core lending business is likely to recover well in the coming three to five years, whereas JPM may well face greater headwinds from investment banking competitors. With the two companies’ Return on Total Assets measures converging over the same time period, patient investors would be wise to consider whether BAC’s severely discounted price, while justified in the coming year, may make the stock a relatively more attractive, if still risky, three- to five-year capital appreciation play.
At the time of this article’s writing, the author had a position in Citigroup (C).