What gives JPMorgan Chase (NYSE:JPM) its premium valuation? According to one analyst, it's having a CEO who certifies flawed internal controls processes and otherwise obscures risk so shareholders think their investment is safer than it actually is.
That's right... according to Charles Peabody, an analyst at Portales Partners, "shareholders may just find that [JPMorgan's stock] loses its premium valuation" if Jamie Dimon leaves the company. Peabody elaborates, "If that were to occur, is there someone with Mr. Dimon's talents capable of stepping into the breach?"
Here's why I think that's a bunch of baloney.
Given Dimon's recent track record of ticking off regulators, misleading shareholders, and taking on excessive risk, I don't believe his particular set of "talents" hold so much appeal. Here are just a few of his most egregious recent sins:
- After certifying the adequacy of JPMorgan's internal controls in May of 2012, the company had to restate its financials and report material weaknesses in its internal controls in June.
- Dimon obscured risk from shareholders by dismissing investor concerns about the London Whale trades by calling the threat a "tempest in a teapot" even though he was allegedly aware of the size and complexity of the bet and the losses already incurred from it.
- The company took on excessive risk under Dimon through the London Whale trades and chose to deal with risk limit breaches by ignoring them and by altering risk models to obscure the risk.
- An investigation by the U.S. Senate found that Dimon withheld profit and loss data from federal regulators. One employee of the Office of the Comptroller of the Currency (OCC) recalled that the bank would regularly challenge findings and recommendations, and that bank executives would even yell at OCC examiners and call them "stupid."
In the face of Dimon's missteps, I suspect much of JPMorgan's premium valuation has resulted from some of the achievements reported in its 2013 preliminary proxy, including:
- Reported a 15% return on tangible common equity
- Put up record earnings per share of $5.20 in 2012
- Offered five-year compound annual growth rate of 7% in its book value per share
But as I pointed out in a previous article, Dimon's propensity to hide risk by using misleading pricing and risk models suggests that shareholders may not be able to rely on these performance numbers. Let's not forget that it was only a year ago that the London Whale blew a $6 billion hole in JPMorgan's balance sheet, a trade that Dimon obfuscatingly attributed to poor hedging.
To account for this possibility, I think rational investors should apply a "Dimon discount" when valuing JPMorgan's stock to account for the possibility that these performance numbers still aren't trustworthy, or that their achievement still relies on excessive risk.
A familiar tune
When Aubrey McClendon was still the CEO of Chesapeake (NYSE:CHK), the company suffered from a reduced valuation that became known as the "Aubrey discount," even after he lost his seat as chairman. But once the company announced that McClendon was leaving the company, investors bid up the stock price.
While it's not as clear that Dimon is as corrupt as McClendon, I believe investors would do well to take a similar approach to JPMorgan. I think the missteps highlighted above demonstrate that Dimon has repeatedly shown himself to be incompetent, prone to abuse his power, or both. For these reasons, I believe shareholders would do well to remain wary of JPMorgan under his leadership, and to reserve a premium valuation for a more trustworthy leader.