JPMorgan Is A Compelling Long-Term Investment By Eli Inkrot, Sure Dividend
When you’re talking about dividend paying companies (and specifically dividend growth), you’re likely to think about the normal host of characters – the Coca-Cola’s (KO), Johnson & Johnson’s (JNJ) and Procter & Gamble’s (PG) of the world.
You think about large firms that have not only paid but also increased their dividends for years. And then the other companies – the smaller firms or those that have much shorter dividend increase streaks – are easy to forget.
To be frank this could be a perfectly reasonable focus for the dividend investor. If you only concentrate on companies that have increased their payouts for decades, you stand a solid chance of narrowing down your focus to only the highest quality businesses. This tactic doesn’t guarantee success, but it certainly leads you in the right direction.
The firm that I would like to talk about for this article is JPMorgan Chase & Co. (JPM).
Source: JPMorgan Investor Relations
JPMorgan had a long and impressive dividend increase streak for quite some time…
Then the financial crisis came, and what was once a $0.38 quarterly dividend was slashed to just $0.05. For an income investor relying on the cash dividends from this security, that’s not going to be good news. And from this fact alone, it’s easy to write this security off.
However, I would like to make a few points before getting to today’s situation.
First, the dividend was effectively “forced” to be cut. This doesn’t give much solace to the retiree living off dividends, but it is nonetheless interesting to note that JPMorgan had the ability to keep making its payment but the company faced regulators.
Next, often times of distress actually tend to be quite good periods for investment.
And finally, the previous mark has now been restored and is actually higher as the quarterly dividend sits at $0.44.
So let’s keep an open mind and think a bit about the future.
Banks Becoming Utilities: Industry Overview
First I’d like to talk about the sector in general terms. A lot of people are concerned that large banking institutions are becoming more like utilities. As a result of increased regulation, including higher capital requirements, investors are expecting banks to grow at a slower rate than what we have been accustomed to seeing.
The specifics are a bit complex, but the logic is simple. Banks make money by lending out capital (among other services). They earn profits on the difference between the interest they collect (think mortgages) and the interest that they must pay out (think CD’s). In addition, banks are able to utilize leverage to increase the returns that they generate.
The higher the leverage the riskier banks become in poor economic times. So the new regulations require that banks hold more capital and decrease their leverage. Thus the returns that they are able to generate, as compared to say a decade ago, could certainly be lower moving forward.
This is a real possibility and should be thought about appropriately. However, that’s not to suggest that this fate has already been written in stone. For instance, while regulation could certainly act as a headwind, the possibility of higher interest rates in the future could be a tailwind. These items could net out, resulting in reasonable growth after all.
In short, for banking in general I’d expect two things. One, you’d generally anticipate that banks would be safer as a result of the new guidelines. Not “safe” mind you, but at the very least better capitalized and able to take on the next crisis. Second, I would expect the future growth rate of the firms to be in line with or even a bit below what it has been in the past.
Now I’d like to move on to JPMorgan specifically.
JPMorgan The Business
JPMorgan CEO Jamie Dimon’s most recent shareholder letter summarizes the business very well. The level of communication in the shareholder letter is higher than what most corporations give.
The image below shows how JPMorgan has continued to thrive over the last decade – despite the Great Recession:
Remember that increased regulation results in the possibility for slower growth; that’s the negative. The positive is that you’re also “forcing” the banks to become stronger.
Here’s a particularly telling exchange framed as a Q&A in the letter:
Question: “You say you have a “fortress balance sheet.” What does that mean? Can you handle the extreme stress that seems to happen around the world from time to time?”
Answer: “Nearly every year since the Great Recession, we have improved virtually every measure of financial strength, including many new ones. It’s important to note as a starting point that in the worst years of 2008 and 2009, JPMorgan Chase did absolutely fine – we never lost money, we continued to serve our clients, and we had the wherewithal and capability to buy and integrate Bear Stearns and Washington Mutual.”
I think that’s an important starting point.
It’s so easy to get wrapped up in the idea that we’re talking about a bank and the financial crisis happened. Or that the dividend was cut significantly and the share price was basically cut in half.
Yet during all of it, every quarter, JPMorgan was still turning out a profit. Granted the profits did fall dramatically, but it was never as if the company was in jeopardy.
One of my sayings is that:
“a business that doesn’t make money doesn’t get to call itself a business for very long.”
Well there’s a corollary to that:
“It’s hard to go bankrupt if you keep generating profits.”
It’s Hard To Go Bankrupt If You Keep Generating Profits
There was certainly a lot of fear out there, but JPMorgan as an ongoing concern remained steady. And just as importantly, if the company can still generate profits in the worst of times, it gives you an idea of what’s possible for better times.
Later on in the shareholder letter Jamie Dimon added the following information related to the Comprehensive Capital Analysis and Review (CCAR) that is performed each year:
“The capital we have to bear losses is enormous. We have an extraordinary amount of capital to sustain us in the event of losses. It is instructive to compare assumed extreme losses against how much capital we have for this purpose.”
“JPMorgan Chase alone has enough loss absorbing resources to bear all the losses, assumed by CCAR, of the 31 largest banks in the United States. Because of regulations and higher capital, large banks in the United States are far stronger. And even if any one bank might fail, in my opinion, there is virtually no chance of a domino effect. Our shareholders should understand that while large banks do significant business with each other, they do not directly extend much credit to one other. And when they trade derivatives, they mark-to-market and