JP Morgan Financial Returns and Capital Constraints
In evaluating the financial position, a firm conducts an in-depth analysis of the financial returns and the associated risk to get an idea of how much the company can withstand. An evaluation of JP Morgan was done in this review to determine its current findings. The findings would show that the firm has a huge reliance on net profit margin to improve its ROE. The data further shows that the company is struggling to keep up with the changes in the market. However, JP has a huge footing to identify other avenues of growth especially considering its current share is overvalued making it unappealing to invest. In addition, it would wise to avoid this share considering the company is at logger heads with the government.
Expected Financial Returns and Associated Risks
- Return on Equity (ROE) for JP Morgan (Morningstar, 2020)
- Net Profit Margin
= net income / revenue
= 34.64 / 115.63 (billion)
= 0.3
Net profit margin shows that JP Morgan generated $0.3 in net income per every dollar of sales. As a general rule of thumb, net profit margin of above 20% is considered good. A 30% net profit margin, therefore shows JP Morgan has operating efficiency.
- Asset Turnover Ratio
= Revenue / average asset
= 115.63 / 2,687.38
= 0.043
JP Morgan generated $0.043 prevent dollar invested in assets. This means the institution had lower asset use efficiency.
- Financial Leverage
= Average Assets / Average equity
= 2687.38 / 261.33
= 10.28
ROE = 0.3 * 0.043 * 10.28 = 0.133
The equity multiplier shows JP Morgan is in a weak capital structure with significant part of its assets financed by debt. Equity only finances 9.72% of the total assets. The overall analysis shows that the key drivers for the company’s ROE is net profit margin.
- Constant Growth Stock Valuation (CGSV)
- Price = Dividend / RRR – Growth rate
- Grow rate = retention rate * ROE
Retention rate in 2019 = 59.36%
Therefore, g = 59.36% * 0.133 = 7.89%
- Expected returns = Rf + B (Mr – Rf )
Risk free rate = 0.8% (10-Year Treasury Constant Maturity Rate as of 21st October 2020 (Guru Focus, 2020)).
JP Morgan beta = 1.13 (Yahoo Finance, 2020)
Assumed market returns = 8%
Expected returns = 0.8% + 1.13 * (8% - 0.8%) = 8.936%
- 2019 dividend = $3.3
Price = $3.3 * (1 + 7.89%)) / (8.936% - 7.89%)
Price = $3.56 / 0.01046 = $340.34
As of 21st October, 2020, the share price of JP Morgan was trading at $100.12. This means the prevailing stock price is lower than intrinsic value of the company’s shares as per CGSV. The stock is thus highly overvalued in the stock market and would be recommendable a “buy-and-hold” stock.
Capital constraints facing JP Morgan
JP Morgan must be aware of the hard capital constraints if it wants to strengthen its competitiveness in the banking industry. Hard capital rationing represents constraints imposed on the company by situations that are beyond the company’s control. The banking industry within which JP Morgan operates is heavily regulated especially after 2008/2009 financial crisis. Banks have been under constraints monitoring by various authorities from EU and USA. Various banks have faced probes from different governmental agencies with accusation of facilitating money laundering, emerging in unethical business practices, or manipulating their customers.
Currently, a major capital challenge facing JP Morgan is the underway investigation into the banks trading practices. The bank is expected to pay almost $1 billion in fine to resolve government investigation into alleged manipulation of Treasury and metal markets (Giel and Hugh, 2020). The Justice Department, SEC, and CFT, have been carrying out probes on the financial institution since 2019. JP Morgan can use financial forecasts (based of likely charges that the institution may face) to evaluate the likely impact of regulatory constraints. Financial forecasts would help to estimate the two amount of penalties that the bank may be forced to pay and the financial implications that various probes may have on the financial performance of the bank both in short term and in the long term.
References
Giel D., and Hugh S., (2020). JPMorgan to pay almost $1 billion fine to resolve U.S. investigation into trading practices. CNBC News. https://www.cnbc.com/2020/09/23/jpmorgan-to-pay-almost-1-billion-fine-to-resolve-us-investigation-into-trading-practices.html
Guru Focus (2020). 10-Year Treasury Constant Maturity Rate. https://www.gurufocus.com/economic_indicators/37/10year-treasury-constant-maturity-rate
Morningstar (2020). JPMorgan Chase and Co DR JPM. https://www.morningstar.com/stocks/xbue/jpm/financials
Yahoo Finance (2020) JPMorgan Chase and Co. (JPM). https://finance.yahoo.com/quote/JPM?p=JPM