Berkshire Hathaway (NYSE:BRK-A)(NYSE:BRK-B) CEO Warren Buffett has now been dumping bank stocks for three straight quarters. But I was still surprised to see the Oracle of Omaha virtually eliminate Berkshire's stake in JPMorgan Chase (NYSE:JPM) in the third quarter of 2020.
Berkshire cut its holdings of JPMorgan from 22.2 million shares, worth more than $2 billion, to less than 1 million shares, worth less than $100 million. That's down even more since the end of 2019, when Berkshire owned more than 59 million shares of JPMorgan, valued at nearly $8.3 billion. With just a fraction of the ownership Berkshire used to have in JPMorgan, is America's largest bank still a Warren Buffett stock? Let's investigate.
Buffett is a value investor
It's been well documented that Buffett follows the same school of thought as another legendary investor, Benjamin Graham. Buffett was a student of Graham's while studying at Colombia Business School, and also says that Graham's book, The Intelligent Investor, changed his life.
Graham is considered the father of value investing, a strategy that involves looking for stocks that seem underpriced relative to their intrinsic value. Graham has seven criteria for value investing:
1. Adequate size of the enterprise
2. A sufficiently strong financial condition
3. Earnings stability
4. Dividend record
5. Earnings growth
6. Moderate price-to-earnings ratio
7. Moderate price-to-book ratio
We could go through all seven of these individually and in depth as they relate to JPMorgan, but I think we can pretty easily check off the first five of these criteria for the bank without having to do too much research. Yes, there are probably banks with higher dividend yields, but JPMorgan has consistently increased its common dividend over the last decade, and has also returned plenty of capital to shareholders through share repurchases as well.
The two criteria in Graham's value investing formula that we should use for JPMorgan are moderate price-to-earnings (P/E) ratio and moderate price-to-book ratio. Graham didn't really write this criteria with banks in mind, so instead of price-to-book ratio we will use price-to-tangible book ratio, which is a better look at a bank's intrinsic value.
Graham believed that "current price should not be more than 15 times average earnings of the past three years." According to Yahoo! Finance, analysts on average estimate that JPMorgan will generate earnings of $7.59 per share for 2020. In 2018 and 2019, the bank generated diluted earnings per share of $9 and $10.75, respectively. That makes the average earnings per share for the company roughly $9.11 for the last three years, resulting in a 14.4 P/E ratio ($131.55/$9.11), so JPMorgan actually does meet Graham's criteria for moderate P/E ratio.
Price-to-tangible book ratio
The only criterion left for JPMorgan to fail is price-to-tangible book ratio, and this is where JPMorgan might have fallen out of favor with Buffett. Graham says current price should not exceed 1.5, or 150% times the last reported book value, or in our case tangible book value. Here are recent price-to-tangible book ratios for all of Buffett's current bank holdings after the market closed Jan. 6.
|Bank||Price-to-Tangible Book Ratio|
|American Express (NYSE:AXP)||488%*|
|Bank of America (NYSE:BAC)||159%|
|Bank of New York Mellon (NYSE:BNY)||183%|
|JPMorgan Chase (NYSE:JPM)||206%|
|M&T Bank (NYSE:MTB)||175%|
|PNC Financial Services Group (NYSE:PNC)||164%|
|Synchrony Financial (NYSE:SYF)||234%|
|U.S. Bancorp (NYSE:USB)||205%|
|Wells Fargo (NYSE:WFC)||101%|
As you can see, JPMorgan trades at more than two times tangible book value. Graham does say that a P/E ratio below 15 can justify a higher tangible book value, as long as the P/E ratio multiplied by the price-to-tangible book ratio does not exceed 22.5, in a formula known as the Graham multiple. However, JPMorgan's Graham multiple comes out to 29.7 (14.4 x 2.06).
Now, this methodology is obviously not perfect because U.S. Bancorp is now trading at a similar valuation as JPMorgan, while American Express and Synchrony Financial trade at much higher valuations. While technically licensed as banks, American Express and Synchrony are really credit card companies, a much different model from the others, and Buffett has owned U.S. Bancorp, long known as one of the strongest regional banks, since 2007. Also, Graham developed value investing in the 1920s and wrote the The Intelligent Investor in 1949, so I am sure Buffett has many other factors that go into his investing philosophy, although the seven criteria listed here are definitely a good framework.
Likely not a Buffett stock anymore
Even though I still view America's largest bank as a good investment, I no longer see it as a Buffett stock, mainly because of its high valuation. I would also not be surprised to see Buffett eliminate his position in JPMorgan entirely in the near future. Earlier on in the pandemic, Buffett cut most of his stake in Goldman Sachs before eliminating his entire position the following quarter.