Jamie Dimon’s Letter to Shareholders, 2014

“So our ultimate goal is to think like a long-term investor – build great franchises, strengthen moats and have good through-the-cycle financial results. Achieve the benefits of scale and eliminate the negatives. Develop great long-term achievable strategies. And manage the business relentlessly, like a great operator. Finally, continue to develop excellent management that keeps it all going. As Thomas Edison said, ‘Vision without execution is hallucination.'” —Jamie Dimon, Letter to Shareholders, 2014

One of the Best Shareholder Letters

Skärmavbild 2015-04-13 kl. 20.01.16JP Morgan Chase (JPM) has released its 2014 annual report that contains the shareholder letter from Jamie Dimon (Chairman and Chief executive officer).

As many times before, the shareholder letter is a great read. It’s written in a simple way that makes it easy to read and understand. Dimon not only brings up the successes, but also discusses the disappointments in a credible way. Other areas that reviewed are opportunities and threats and different kinds of moats enjoyed by JPM. Dimon also mentions Mr. Market, and there are a few familiar words and expressions.

Click image to the right to read the 2014 letter to shareholders.

Diluted Earnings and Tangible Book Value per Share

Let’s start with a quick recap of fiscal year 2014.

Diluted earnings per share (EPS) increased by 21.6% to $5.29, although diluted earnings per share was slightly unchanged compared to 2012.

Tangible book value per share grew to $44.69, an increase of 9.5% from last year’s $40.81. According to Dimon “…the growth in tangible book value per share, […] is a conservative measure of value.” Feels like something we have heard someone else say (could it be Mr. Buffett…).

The CAGR in tangible book value per share during the last 3, 5, 7, and 10 year-periods has been 10.0%, 10.6%, 10.8%, and 11.4%. In other words, growth in the years gone by has been pretty stable and consistent for JPM.

Looking at earnings, average diluted EPS during the last 3, 5, 7, and 10 year-periods has been $4.95, $4.66, $3.84, and $3.76.

Return on tangible book value per share during the same time periods amounted to 12.0%, 12.5%, 11.0%, and 13.2%. This compared to a return on tangible book value per share of 11.8% in 2014. Return on tangible book value per share hit a low in 2008, falling to 6.0%, and peaked at 21.2% in 2006.

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Content

The following areas are discussed by Dimon in the shareholder letter:

  • JPM’s outstanding franchise.
  • The long term opportunities and threats to the business.
  • The New global financial architecture, and how the evolving regulatory environment affects JPM.
  • The business strategy and future outlook, and what to and worry about.
  • Engagement from the board of directors, management team and JPM corporate culture

I’m will not go into more detail regarding these different areas, just briefly touch upon a few things.

Peer-Comparison: Efficiency and Returns 

Comparing yourself against relevant peers is very important, and the letter contains a few words about this plus a great table with different peer comparisons.

“We always compare our margins and returns with those of our best competitors in each business. The chart below, which is very similar to a chart we showed at our Investor Day, shows some of these numbers for 2014. We believe that the right discipline is to compare each of our businesses against its best competitor. It is a mistake just to look at the consolidated numbers and compare them – every company has a different mix of businesses.”

JPM2

“A good company should be able to earn competitive margins over an extended period of time regardless of economic conditions while investing and without taking excessive risk.”

“Does what you do work for clients?”

Dimon’s discussion of JPM’s business and its moats gives a great view of how management looks at the business.

“All companies, including banks, have a slightly different mix of businesses, products and services. The most critical question is, “Does what you do work for clients?” Our franchise does work for clients by virtue of the fact that we are gaining share in each of our businesses, and it works for shareholders by virtue of the fact that we are earning decent returns – and some of our competitors are not.

Other considerations are whether your company has “moats” – is it protected in some way from debilitating competition or events? And has it performed consistently – in good times and in bad? We believe that we have well-fortified moats in the form of economies of scale, brand, expertise, technology and operations, and – importantly – competitive advantages created by our ability to cross sell (more on this later in this letter).

In addition, we have performed fairly consistently in good times and in bad. Even in 2008, the worst year in perhaps 75 years for financial companies, we earned 6% return on common tangible equity – not great but not bad, all things considered. Additionally, we have embedded strengths that are hard to replicate – the knowledge and cohesiveness of our people, our long-standing client relationships, our technology and product capabilities, our fortress balance sheet and our global presence in more than 100 countries.

[…]

Part of our mix of businesses, however, is not unique. While we divide our company into four distinct businesses, the truth is that many regional banks do a lot of what three of our four businesses do (i.e., Chase Consumer & Community Banking, Commercial Banking and Asset Management). The biggest difference between us and regional banks is our global Corporate & Investment Bank (and the non-U.S. part of our Asset Management business).

Our broad product set and some of our unique capabilities (some we inherited, and some we built carefully over time), combined with effective cross sell, create substantial competitive advantage.”

JPM Value Range

A discount rate of 10% and an assumed return on tangible book value per share of 13% coupled with a growth rate of 5% going forward results in a price to tangible book multiple of 1.6*, or an estimated intrinsic business value per share of approximately $72.

JPM’s ROE target is 15% (see image above). Using the same assumptions for required return and growth together with this 15% ROE gives a price to tangible book multiple of 2, and thus a value of $89. I think that using this ROE target might be too aggressive. But, it shows the potential upside if JPM is able to reach a sustainable ROE of 15%. In the last ten years ROE has never been this high, but we also saw a financial crisis etc.

So, from the above calculations we get an intrinsic business value range of $45-90 per share. The lower end consists of the current tangible book value per share, and the higher end being the potential (and from my view also aggressive) value from reaching the current ROE target of 15%.

A fair intrinsic value range may be a price to tangible book multiple of 1.3-1.7, resulting in a per-share value in the range $58-$76.

JPM is currently trading at a price per share of $64.14 (Price to TBV: 1.44, P/EP: 12.8)

JPM will be added to the watch list.

*Equity-value-to-book-multiple = 1+[(ROE-COC)/(COC-G)]

Annual Report, 2014

Click image below to read JPMorgan’s annual report for fiscal year 2014.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments. 

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