President-elect Donald Trump couldn’t be more optimistic about bank stocks, which have lagged the broader market for years. Trump could roll back banking regulation, or simply pay less attention to the banks — a change from the control they received from the Biden administration. Bank mergers and acquisitions are likely to be approved more quickly, and a Trump presidency and lower interest rates could lead to more dealmaking and initial public offering activity, boosting investment banking revenues.
The two largest banks in the US JPMorgan Chase(NYSE:JPM) And Bank of America(NYSE: BAC)have already seen their shares rise by about 8% and 10% respectively since Election Day. It may not seem like much compared to some of the artificial intelligence high-flyers in the market today, but it’s a big move for highly liquid, blue chip stocks with modest volatility. After the big move, Wall Street sees limited upside potential for one of these stocks, but rates the other as a strong buy.
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With approximately $4.2 trillion in assets, JPMorgan Chase is the largest bank in the US. The stock is up about 40% this year, which is another huge move for a stock with a beta roughly in line with the broader market.
While several banks failed in 2023 due to poor balance sheet management in the high interest rate environment, JPMorgan Chase has benefited. Treasurers and CFOs of companies who did not want to do their business with a bank that could fail flocked to big banks like JPMorgan, which are too big to fail. Additionally, the banking crisis allowed JPMorgan to acquire First Republic in an FDIC-backed deal.
While First Republic would likely have gone bankrupt had it not been acquired, JPMorgan Chase gained a bank with a strong affluent customer base. JPMorgan Chase would not have been allowed to close the deal under normal circumstances because it already has more than 10% of the US deposit market share and therefore cannot legally buy any more US banks. The deal also involved loss-sharing agreements with the FDIC.
Lower interest rates, friendlier governance and a steepening yield curve should benefit JPMorgan Chase. However, analysts believe the market has already factored these tailwinds into the stock price. Over the past three months, 19 analysts have issued reports on JPMorgan Chase, with 13 rating the stock as a buy, five saying to hold the stock and one saying to sell. The average consensus price target of around $234 implies a downside of around 3%.
Analysts’ caution has more to do with valuation than with the actual business. JPMorgan Chase trades at more than 2.6x a bank’s tangible book value or net assets. This is nearly the highest valuation JPMorgan Chase has had after the Great Recession. CEO Jamie Dimon is a great leader and the company is undoubtedly one of the best banking stocks of its kind, but the valuation is now too high.
Long-term investors can still hold the stock without too much concern, given the quality of the company. More active investors may want to take profits and wait for a pullback. I recommend the active strategy more for retirement portfolios with fewer tax implications.
It’s interesting. Bank of America and JPMorgan Chase trade on the same fundamentals, and the consensus analyst price target for Bank of America implies only small upside potential. However, analysts still consider Bank of America a strong buy. Wall Street brokers have issued 16 reports in the past three months, 14 of which said to buy and two said to hold.
So what gives? According to Citi Group Analyst Keith Horowitz, Bank of America could soon have a similar valuation to JPMorgan Chase, which has essentially set the market for the largest bank stocks. Currently, JPMorgan Chase has a cost of equity (COE) of 8.7%, compared to Bank of America’s 10.2%.
COE represents the required risk premium to invest in a stock. In other words, investors expect Bank of America to generate 10.2% on their equity when they invest. This is of course more of a technical exercise, but it is very important in determining the valuation. Horowitz expects valuations to converge and a “lighter regulatory environment” to potentially push Bank of America yields above Citi’s normalized assumption of 15%.
Bank of America’s balance sheet problems overshadowed its shares. Bank of America bought too many long-term, low-yield bonds before interest rates soared. These bonds became deeply submerged, resulting in paper losses that hurt Bank of America’s tangible book value. Management then added swaps and other derivatives, further limiting interest rate risk but losing bank revenue. As interest rates fall and with each passing quarter, paper losses will decrease and swaps will expire, increasing Bank of America’s tangible book value and increasing profits.
Bank of America now trades at 1.75x tangible book value (as of November 11). Long-term investors can continue to hold the shares. Bank of America and JPMorgan Chase are set it and forget it stocks that should serve investors well in the long run. For more active investors, I recommend trimming or selling Bank of America once it reaches 2x tangible book value, which would be when the stock reaches $52.50. It all depends on your trading style.
Consider the following before buying shares in Bank of America:
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Citigroup is an advertising partner of Motley Fool Money. Bank of America is an advertising partner of Motley Fool Money. JPMorgan Chase is an advertising partner of Motley Fool Money. Bram Berkowitz has positions at Bank of America and Citigroup. The Motley Fool holds positions in and recommends Bank of America and JPMorgan Chase. The Motley Fool has a disclosure policy.
Bank of America Stock vs. JPMorgan Chase Stock: Wall Street Sees Limited Upside in One, But Rates the Other as a Strong Buy was originally published by The Motley Fool
