Tickers mentioned in this show: JPM

Tidal River Investments positions the day after the first show airing:

Long: NFLX, ETSY, SPY, TDOC, U, Z, ZG, WK, ATVI, AVGO, JPM

Show Notes: Collected JPM data spreadsheet

3Q2021 Earnings Call transcript

Photography from Tidal River Investments can be purchased at tidalriverinvestments.com

Script

Welcome to Fluctuating Tides, Episode 9. I’m your host, SomeCodingGuy, and let’s get right to it!

This week I’m going to be covering JPMorgan Chase, ticker JPM, a very large multinational diversified bank that’s quite a bit different than most of the stocks we covered previously, which is a good thing considering how many tech stocks I’ve been covering to date. Banks are analyzed a bit differently than tech and medical companies, and to get started with this company’s filings, we need to first talk about ROE.

What is ROE? Return on Equity, a common measure used for analyzing banks, gives us a general idea of how well a bank makes money, but it’s a little more complicated than that. To calculate it, first we need to know what “equity” means - in this case, which is just the assets, or things of value the company possesses, with the liabilities, or things the company owes like debts, removed. The value left over is usually called the “Shareholder’s Equity”, “Book Value”, or “Net Assets”. We divide that into the 12 months of net income to get the ROE, which gives us a fundamental measure of how much money it makes based on what it has to work with, but we’ll get to that in a moment.

To take an example, let’s say I had a business with 100 bucks to invest, and I borrowed $50 to get started. So at the start of the year, I have $100 dollars in assets, less $50 in liabilities, so I have net assets of $50, if I paid it off today. Now let’s say I have a great quarter, making 10% on the 100 I invested, so my net income is 10 bucks. 10 bucks in net income divided by 50 bucks in equity, so I had 20% return on equity for the quarter. Now next quarter, I probably should pay the 50 bucks back, but given how low interest rates are, maybe we’ll put that off until we want to do a more complicated example!

Now most of the time, businesses don’t just magically make 10 bucks out of 100, but in the more general case, the business usually has to build whatever it sells from raw supplies that it turns into finished products ready to be sold. Before they sell them, we call them as “inventory”, but after selling them they become revenue, and if this was a public company, the related costs of making the items sold would show up on the income statement as “cost of goods sold”.

Most of the businesses that we’ve covered so far fit into this category, such as Zillow buying a house and fixing it up to sell, or Broadcom taking a silicon wafer and turning it into microchips, but for some businesses the goods themselves can’t be seen or touched - we call those intangibles, and Unity’s game development software or Blizzard’s game catalogue fit into this category, but the idea still boils down to taking some basic components and selling them for more than they cost. Looking at how expenses relate to the revenue was covered in earlier shows when we talked about “net earnings” or “net income”, and we looked at comparing sales with the expenses needed to make them, but in the case of net assets, we’re talking more about what the company has at the moment that’s worth something instead of how much in made in sales or how profitable it is in a quarter.

Banks, on the other hand, derive their revenue from a few sources, usually split between fee based products and non-fee based products. We’re all familiar with fees, but for a big investment bank, that might include things like taking a company public through an IPO or delivering cash around the world, but non-fee based revenues often involve a spread between rates. Back in the day, the classic example was paying a customers 3% interest on their savings, keeping some of the money on hand if you needed it, and then lending the rest out for people to buy houses with a mortgage paid back at 6%. Banks also used to close at 3PM back then, leading to the term the 3-6-3 crowd, but I haven’t heard of that working in the US in recent memory.

That type of non-fee revenue works based on the spread between how much it costs you to borrow the money (in this case, 3%) and how much you can earn on it (in this case, 6%). These days, there’s far more complex versions of this idea in common use by the big banks, but the general idea of “playing the spread” between various rates is still a common way to think about these things. Loans are very low interest these days due to a number of factors, but JPMorgan still expects to make about $53b this quarter.

In the case of a bank, things are a little bit flipped from our usual understanding of businesses. Depositing in a savings account shows up as a liability to a bank, since that’s not really the banks money, they’re effectively borrowing it from the depositors based on the interest rates they pay out. It can also be an asset if they keep the cash on hand, but like I said, things can look a little different from the bank’s perspective, so keep your eyes opened when looking at the financial statements.

Now JPMorgan-Chase is a very big bank. Their business lines are involved, and their most recent quarterly filing covering the last three months is 193 pages long, before getting to all of the attachments, so you might want to pour a few cups of coffee before settling down to read it. The detail is fantastic, however, and there’s quite a lot you can learn paging through it, and their CEO, Jamie Dimon, has been called the “smartest guy on Wall Street” a number of times through his career, which doesn’t hurt their reputation any.

Regardless how clever their CEO is, let’s take a look at a few of the numbers. I’ll try to keep this analysis simple, and we’ll circle back in future episodes to cover this in more detail. The bank uses a number of preferred stock classes in addition to common stock, so to get ROE on a common stock basis we’ll need to back a few things out vs. a company with a single class of shares, which I cover in more detail in the spreadsheet attached in the show notes, but at a high level, to get ROE, we need the Net Income (on an annualized basis) and the Shareholder’s Equity, in this case for the common stock.

As I mentioned, equity is the part left over after taking liabilities out of assets. With the preferred shares and dividends pulled out, that’s about $250b, to use round numbers. Net Income, or the bottom line, was about $12b for the quarter, so times 4 we get $48b for a full year. 48 divided by 250 and we get 19%, or just a hair over the actual 18%, but like I said, this is easier to see with the actual numbers in the show notes. If we wanted a bit more accuracy, we could add up the last 4 quarters worth of net income instead of taking the recent number and multiplying by 4, but for estimating, this gives us a quick idea of what’s going on. The bank also includes this calculation in its financial statements, useful for a quick glance, but I always find it helpful to make sure I know what went into the calculation, just in case I’d rather do my analysis excluding or including certain items.

Alright, so JPMorgan had a regular ROE of 18% for the past quarter. Is that good? Well, depending on how you calculate it, the S&P500 in total is somewhere between 9 and 14%, so 18% sounds pretty good! With the industry average at 13%, and a very healthy balance sheet even with lower returns in the credit card business and housing, the outlook and future branch and digital expansions are interesting, and management has demonstrated flexibility in reacting to evolving market conditions.

Just around the time of this podcast, Chase released an earnings preview ahead of their filings, and the CEO and CFO discussed strong access to capital for further expansion on the balance sheet, with little desire to maintain excess funds. Jamie went on to note in a question regarding additional dry powder (or excess cash to put to work), “We have $1.6 trillion of cash and marketable securities. We have well over $200 million of equity. We can issue preferreds, we can issue debt, we can issue stock, if we had to do something; so I don’t think we need dry powder… I think our capital cup runneth over where it is”.

Given all this, Tidal River is going to take a position in JPMorgan Chase this week.

If you like the podcast and want to see more content like this get created, feel free to subscribe on your favorite podcast app, or buy a photo from tidalriverinvestments.com - money earned on the photos gets deposited in the investment account. As always, Tidal River Investments and I are not financial advisors, market analysts, or otherwise in any way offering advice for or against any of the securities discussed - meet with a financial advisor for that information. Stocks and funds may not be good investments for you, depending on your financial situation.

We’re here for learning, not advice, and I wish you the best on your financial journey, and remember, tides fluctuate!