Over two years ago, Warren Buffett mentioned that he owns 1,000,000 shares of J.P. Morgan in his personal account. He expressed his admiration for the CEO Jamie Dimon, but he did not go into much detail explaining why he thought J.P. Morgan was a great investment. If I had to guess his answer, I suspect it would be this—J.P. Morgan continues to mint money even though the headlines about the company are frequently negative and the company had to cut the dividend during the financial crisis. The gap between actual business results and perceived business results exists when it comes to many banks, and J.P. Morgan is no exception.
Even during the worst of the financial crisis, J.P. Morgan remained profitable. It made $3.6 billion in profits in 2008. The issue is that the company was on the hook for paying out $6 billion in dividends to shareholders (based on the trailing rate), and J.P. Morgan needed to retain capital in case the crisis got worse and was not in a position to borrow substantially without diluting shareholders at a low price or paying outrageous interest rates because the perceived risk. It is perhaps easy for us to now remark with hindsight that the depth of the financial crisis would be largely contained to 2008 and 2009, but the length was unknown at the time and J.P. Morgan had to prepare for it.
That is why, in 2009, J.P. Morgan cut its $1.52 annual dividend to $0.05 per quarter, or $0.20 annualized. Instead of having to pay out $6 billion to shareholders, J.P. Morgan only had to pay out $780 million to shareholders. This dividend reset was important because it allowed J.P. Morgan the opportunity to retain a significant amount of earnings to bolster capital, expand the loan portfolio, and upon receiving clearance from the U.S. government several years later, begin repurchasing its own stock.
Its recovery these past five years is distinguished from Citigroup and Bank of America because J.P. Morgan had very large profits to report while paying a low dividend (Citigroup and Bank of America had their profits obscured by larger legal judgments and settlements to satisfy). And J.P. Morgan is distinguished from Wells Fargo because it had a low dividend payout ratio and so had a larger percentage of profits to dedicate towards forward growth.
Sure, J.P. Morgan has returned over 20% annually from its March 2009 lows, but it has also returned 13% annually (from 2010 through now), and this covers the period after the price of the stock tripled from $15 to $45. The reason why profits have rebounded from the $3-$4 billion range during the recession, to the $11 billion immediately after, to $21 billion now is because of that sizable gap between dividend payouts and the amount of profits that J.P. Morgan actually makes.
In 2010, J.P. Morgan only had to pay out 10% of profits. In 2011, it paid out 25% of profits. In 2012, it also paid out 25% of profits. In 2013, it paid out 36% of profits. Last year, J.P. Morgan paid out 32% of profits. It made $21 billion in profit and only had to pay out a little over $7 billion in dividends to shareholders. By lowering the dividend by a greater amount than was necessary in the aftermath of the financial crisis, it somewhat paradoxically was able to grow the business at a faster rate than would have been the case had there been no financial crisis at all.
Look at the numbers: The loan portfolio grew 6% annually from 2004 through 2014, and the earnings per share grew 11% over the most recent decade-measuring period. It’s this wild thing where someone could have bought $10,000 worth of J.P. Morgan in 2004, taken a Rip Van Winkle nap, and seen his wealth compound at nearly a 7% rate to become $21,000 worth of J.P. Morgan shares today. Yes, that it is one percentage point lower than what you would have gotten by investing in the S&P 500 Index, but is pretty darn impressive when you figure that the decade at one point included 80% dividend cuts, 74% profit declines, and a stock price that fell from $53 to $15 during the worst of it.
Part of the reason for the company’s success is that the profits have not fallen as much as the headlines and valuation suggest, and the dividend reset allowed J.P. Morgan the opportunity to use excess retained profits to develop future growth. Aware of those facts, the recent news about J.P. Morgan should not have been that surprising: J.P. Morgan is raising its dividend 10% this July from $0.40 to $0.44, and is authorized to repurchase $6.4 billion of stock between this April and the end of June 2016. You should expect around $5 billion of that to actually go towards lowering the share count of the stock based on past experience, and this should reduce the share count by about 2%.
What catches my attention is that despite this high dividend growth, J.P. Morgan still has a lower than usual dividend payout ratio. It is now on the hook for paying out $1.76 per share in dividends while making $5.50 per share in profits for a dividend payout ratio of only 32%. J.P. Morgan gets to retain about $0.68 in every dollar of profits it makes to invest for future growth. I would expect earnings per share growth to continue in the high single digit range, as the company’s actual business performance continues to be much better than the headlines suggest.