JPMorgan in 2014: Why Shares Look Attractive

JPMorgan in 2014: Why Shares Look Attractive

Dow Jones Industrials Average component JPMorgan Chase had a challenging year in 2013, to say the least. In the wake of last year's London Whale trading fiasco, which ultimately cost the bank $6 billion, it replaced Goldman Sachs as the focal point of enormous interest on the part of the media -- and regulators. JPMorgan had carefully cultivated a reputation for savvy risk management, managing to remain profitable in every quarter throughout the financial crisis. But it has been humbled recently, posting its first losing quarter since 2004. In that context, how is 2014 shaping up?

First, the bank, led by a smart and forthright CEO in Jamie Dimon, is not simply licking its wounds and standing pat; it has been proactive, particularly in dealing with the legal and regulatory issues that have weighed on shares. That process has accelerated during the second half of this year, which bodes well for 2014.

Legal exposure: The trend looks good
On Nov. 19, JPMorgan announced a massive $13 billion global settlement with government regulators regarding the mis-selling of mortgage-backed securities. Separately, the bank announced two settlements totaling $5.6 billion with private investors and Fannie Mae and Freddie Mac relating to the same issues. Those numbers look huge, but the bank was properly reserved for those outcomes.

I think these actions, particularly the $13 billion umbrella settlement, are a key milestone that demonstrates JPMorgan's determination to definitively draw a line on the soured legacy of the credit crisis. Concluding these settlements is a terrific way to end the year and go into 2014.

Let me be clear: This does not put an end to JPMorgan's legal and reputational exposure -- there is a reason the bank's total litigation reserves stood at $23 billion at the end of the third quarter. There will be more settlements and ongoing investigations in 2014, but the bank is moving through its outstanding legal issues in a workmanlike, rational manner. Furthermore, the organization, in the image of its CEO, has adopted a less confrontational approach and is working cooperatively with regulators. That process has positive implications for the stock.

The stock: attractive in a fully valued market
I will not try to predict where the stock will end 2014; one year is far too short a time frame for anyone to say anything with any degree of confidence regarding a stock. With that caveat in mind, it is possible to discuss a baseline for expectations over the next several years.

As of Monday's close, JPMorgan's stock had risen 32% year to date, beating the Dow and the S&P 500 in the process. A very decent performance, particularly against the backdrop of the negative attention the company has received. That illustrates the pressure the share valuation was already under at the beginning of the year; indeed, at the end of 2012, the stock was valued at a 12% discount to its book value. It now trades at a 9% premium-to-book value; that's the highest such premium since the second quarter of 2011, but it hardly looks unreasonable.

On the basis of forward earnings, the shares trade at just 9.6 times the next 12 months' earnings-per-share estimate, which looks eminently reasonable, both in absolute terms and compared to the S&P 500, which is at 15.3 times. Add to that a 2.7% dividend yield and you have a recipe for market-beating total returns over the next three to five years.

The banking environment has changed dramatically in the years after the financial crisis, but despite its highly publicized travails this year, JPMorgan Chase remains well-positioned at the top of an oligopoly that covers retail, wholesale, and investment banking. The bank's reputation -- and that of its CEO -- may have suffered a blow, but I continue to believe that long-term investors can reap decent returns by betting on this purebred.

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Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on Twitter @longrunreturns. The Motley Fool owns shares of JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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