Let's go to the financial sector, banks, if only to see how they've grown into such huge hungry beasts. While manufacturing sector growth peaked out late fifties along with employee compensation, Wall Street began to stir. Trading floors blossomed into football field sized profit centers.
A typical trading day, late fifties on the Big Board was 4 million shares. Partnership equity for a fair-sized house was no more than $50 million. My starting salary as an in-training security analyst was $100, weekly, and I was happy. Over the next 4 decades, the financial sector spurted to a 10% share of GDP from its village number of 1%.
I referenced this as I read mid-year quarterlies - JPMorgan Chase, Citigroup and Bank of America, I'm overcome with the size and scope of their operating world. Some reports approach 30 pages, chock full of numbers, ratios and year-over-year comparisons. After everything, I'm brain damaged or at least waterlogged by the numbers. Maybe, management's intent.
Before my study session, I held to a definitive point of view born out in my sizable holdings: Citigroup was the obvious room for improvement story. JPMorgan Chase was too high relative to its book value premium and price-earnings ratio. As for Bank of America, I liked it's heavy weighting in Wall Street operations as well as scope in the home mortgage sector. Up from $16 - $24 a share, I felt like a fat cat lapping up his bowl of milk.
All this changed as I read on and silently but furiously extrapolated numbers I was digesting 12 months ahead. It was not exactly where bank stock analysts were coming out. My biggest change of heart was the JPMorgan Chase situation. Remember, of these 3, Citi and BAC included, Jamie Dimon managed through the 2008 – ‘09 debacle just bruised, while the other 2 crumbled close to insolvency.
The House of Morgan sells at 1.5 times yearend book value with quarterly earnings power likely to reach $2 a share. Let's call Morgan at 11 times my 2018 projection. So it's not selling at any great premium in this group of 3. Big earnings leverage rests in the fixed income sector, revenues down 19% year-over-year. Meanwhile, wealth management is ahead 20%. Commercial banking, what I'd consider the heart of the old Morgan business is ahead 30%, a huge advance. Wealth management gained 20%. This is a steady earner. Management projects core loan growth of 8%, sizable in an economy growing at just 2%.
The major issue is whether Morgan pulls ahead of the other 2 in terms of valuation or even if the market’s valuation of bank paper at 60% of the market is still the right number. Conceptually, Morgan could close much of the gap, next couple of years. I'm betting on it happening and not overpaying if my earnings projection is met.
Citigroup, conceptually, carried the biggest room-for-improvement story, but we’re pretty far along there. The enticing comparative is it sells at tangible book value. I see the earnings run rate at $5.20 a share, and 10% better for 2018. So we've got $5.70 to $6 next year. This puts Citi around 11 times next year's optimistic number. Not unlike JPMorgan Chase.
What's to like? Flattish operating expenses (true of all 3). The workout on impaired businesses was successfully executed. Expenses contained and good numbers for investment banking. Fixed income markets were terrible for everyone, but credit and expense level held down.
Like everyone else, net interest margins and revenues rest flattish, year-over-year. Compared with Morgan, Citi holds a big edge on book value but not on earnings power or valuation. You can't own bank stocks for their yield. Managements seem bent on share buybacks. This makes more sense for Citi than JPMorgan. My take as a shareholder is share buybacks benefit management more than us.
This all started years ago with ExxonMobil whose dividend payout ratio was puny. So they then started coupling share buybacks with dividends, a management conceit, pure and simple. Buybacks benefit management. Their options positions exceed share ownership. All big cap spokesmen talk the same talk. Read proxy statements, a tough plow through, but you'll get the drift on management rapacity. Don't get me started on tech house compensation where there's an enormous spread between GAAP and non-GAAP reported earnings.
Management’s take is lump in dividends with share buybacks because cosmetically, it makes them look good. I'd like to see all 3 pay out 60% of earnings in cash dividends. This would put a respectable yield on Citi. Say a $3 dividend on a $66 stock gets you comfortably over 4%. Don't count on it. Not an AT&T kind of situation.
Finally, Bank of America who I give the palm for 27 pages of jitterbugging complexity and charts that made me as cross-eyed as a rabbi listening to a tale of ribald adultery in his congregation. I see BAC’s earnings power around $2 a share next year so valuation matches the same zone as Morgan and Citi. The quarterly is curious because there’s minimal bullet point sentences. They want you to do all the work. I challenge whether any shareholder missing a chartered financial analyst’s designation can make sense of these 27 pages of analytics.
What did I like? Earnings rose 10% with expenses under control and net interest income up 9%. Its wealth management business is a $2.6 trillion business, bigger than Morgan's. Much of it comes from the acquisition of Merrill Lynch in the dark days of 2009. BAC made Buffett around $11 billion richer when it issued him a ton of warrants exercisable around $7 a share,7% dilutive. Even Goldman Sachs needed liquidity then and sold Berkshire several billion in a high yielding preferred stock, just recently redeemed.
Management also bullet pointed capital returned to shareholders doubled in the first half. But, actually the cash dividend yield is a thin 1.25%. A 50% payout, say a buck on an earnings base of $2 would yield over 4%, but don't hold your breath, it's years away.
Return on average assets edging up but still comparatively low at 0.93%. Same goes for return on equity at 11.2%. These numbers are much below Morgan’s and Citi’s. On its nearly $10 billion share base, BAC approximates $230 billion market capitalization. It sells at nearly a 30% premium to tangible book value which puts it on the pricey side, comparatively with Citi.
Stand back, then take a wide-angle snapshot. There's an awesome magnitude in terms of market capitalization and asset base numbers, what Morgan calls managed revenue. Their asset base runs around 10 times their equity. Morgan's market capitalization tops $300 billion and puts it in the top 10, like Facebook, Alphabet and Amazon. But, Morgan dates back over a century while Internet properties are around little more than a decade.
Fixed income and equity market revenues first half shut down for all of Wall Street. This could turn around next year, but is not forecastable. The big question: is 11 times forward 12-month earnings power the right valuation for all 3? I'm betting it's low relative to the market multiplier of 18. But, recent history is against me, 2008 – ‘09. They're all handling themselves better now in our slow growth setting. With 10-year Treasuries easing back to yield approximately 2.2%, I'm still a patient holder. After all, you don't dare put all your money into tech houses selling at over 25 times next year's operating cash flow.
Inequality flourishes everywhere.
Sosnoff owns: JPMorgan Chase, Citigroup, Bank of America, AT&T, Facebook, Alphabet and Amazon.
msosnoff@gmail.com
