Date Published
13 July 2021

Article Posted by
Mark Ingham

Featured topic
US Securities Strategy – banks

Synopsis:

We’re keeping track of US money centre bank earnings this week and a jolly good set of Q2 number they’ll be too. Banks in particular are a useful barometer for Ingham Analytics, a sector we keep close tabs on. In addition to rapidly improving earnings, admittedly off a depressed base due to high historic impairments, dividends are also recovering whilst capital ratios are generally sound.

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US Securities Strategy – banks
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“Off to the races”

In our note yesterday “Give us a rev” we mentioned that US company profits are going to rise by a prodigious amount. With US earnings season upon us we examine some granularity around bank earnings and why, as we indicated in our previous note, multiples may not be so stretched on a forward basis. US banks such as Bank of America and Citi will be in the spotlight for us this week although money centre banks are now fully priced for our money, as are Australian banks which were our favoured geographic bank sector in 2020. Lower provisions for credit losses will continue to be an earnings driver. Dividends are recovering. What’s not to like.

This week earnings season get underway in the United States. Banks in particular are a useful barometer for Ingham Analytics, a sector we keep close tabs on. What is noteworthy about this past COVID-19 eighteen months or so is how well the large “money centre” banks have come through the crisis, helped by decent balance sheets going into the pandemic induced economic downturn and a lot of stimuli, both monetary and fiscal, sloshing around.

Dividends are perking up. On 28 June, Morgan Stanley announced a 100% increase of its quarterly dividend from $0.35 to $0.70 per share and authorised the repurchase of up to $12 billion of common stock over the next 12 months.

We’ve seen a similar trend with Australia banks, a geographic sector we like and which we have recommended investors seeking exposure to banking consider, even ahead of US banks (shock horror).

If you’d taken our advice last year, you’d have made a tidy sum on the likes of Westpac, ANZ, Bendigo & Adelaide and Commonwealth, the whale in the Australian banking pond, all being priced for Armageddon at one point.

You’ve also had an AUD FX tailwind as the AUD strengthened against the USD, reaching a bottom of AUD1.80/USD in March 2020 before strengthening to around AUD1.30/USD, that’s a more than 25% strengthening of the AUID.

ANZ (green), Westpac (red), Bendigo & Adelaide (blue), Commonwealth (yellow)

AUD/USD exchange rate

US banks haven’t done badly either, recovering sharply from mid-2020 lows.

Bank of America (red), Citi (purple), JPMorgan (black), Goldman Sachs (gold)

Of the big money centre banks, Bank of America Q2 results will be released at 06:45 a.m. ET on Wednesday, 14 July followed by an investor presentation at 09:00 a.m. ET. Also on Wednesday, Citigroup reports at 08:00a.m. Goldman Sachs and JPMorgan Chase are first out of the starting blocks on Tuesday, 13 July in the morning.

If Bank of America reports $0.75 per share for Q3 it will imply a doubling of earnings on Q2 2020 and 27% higher than Q4 in 2020. Expect a CET1 ratio of 12%. If Bank of America reports $3.05 per share for the year that is a 63% jump in earnings. At a share price of $40 the forward PE ratio is 13.1x, down from a trailing 21.4x and a trailing calendar twelve-month multiple of 17.1x. When your earnings are recovering at this rate what seems like a lofty historic number soon looks reasonable.

Citi reported earnings 242% higher in Q1 and we expect a strong year of recovery too. At $68 the share price has already improved to a trailing twelve-month multiple of 9.0x. You are also only paying 77% of book value or 90% of tangible book value for the stock.  

JPMorgan meantime we think will report $3.15 for Q2, up 128% from Q1 2020, and for the full year we estimate north of $13 per share in earnings, up at least 45%. At a share price of $155 that means a forward PE ratio of less than 12x.

And that investment banking juggernaut Goldman Sachs hasn’t had a bad COVID-19. Assuming Goldman reports $10 per share for Q2 that’ll be a rise of 60%. We think they’ll top $45 per share for the full year, up 80%, so at a share price of $370 the forward PE is only 8.2x.

As the graph below shows, whilst the S&P 500 index PE multiple may seem toppish, when earnings are growing quickly that PE soon degrades. The current forward PE is 22x, but you’d need less than 20% further earnings growth into 2022 to bring that down to the five-year average of 18x. Sure, 15x to 16x may seem like a more acceptable ratio relative to several years ago but cost of money is lower, and the composition of the S&P 500 also changes with time – the top 10 today has little resemblance with the top 10 of a decade or two ago. 

S&P 500 forward price earnings ratio

As mentioned, we think corporate America is on track for around 30% earnings growth this year, maybe more. With S&P 500 companies likely to report an aggregate 64% rise in Q2 profits that 30% is not outlandish as the run rate is improving. We mentioned in our previous note that the Federal Reserve has been caught flat footed on expectations, taken up in the panic of the moment.

Quarterly earnings growth of the S&P 500 index

 We’ll keep you in the loop. Happy trading and investing.