Foolish Four Portfolio
Jumping for Joy
JP Morgan announces earnings
By
RESTON, VA (Oct. 18, 1999) -- One of the bright spots in the market today was Foolish Four denizen JP Morgan <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JPM)") else Response.Write("(NYSE: JPM)") end if %>. The giant banker announced earnings today. The stock, which has been sliding for weeks on fears of interest rate increases, jumped 7 5/16 points, nearly 7%.
However, the earnings picture is not quite what some headlines indicated. Although both the Associated Press and Reuters headlines screamed "Profits Nearly Triple," those profits are up that much only compared to last year's third quarter profits, which were a mess due to the Asian crisis. (Remember that?) Usually, this is the correct way to report changes in earnings, and, to be fair, Reuters does mention the problem with last year's earnings in the fifth paragraph. But the picture isn't quite as amazingly rosy as the headlines paint it.
Comparing a company's performance to the same quarter of the previous year is a good idea. It eliminates seasonal bias. For example, it would hardly be fair to compare a company's spring retail sales with its Christmas season sales. Many companies experience less extreme forms of seasonality, so comparisons are routinely made with the "same quarter last year."
In this case, the proper comparison would lead to a misconception if you are trumpeting "earnings triple." It's kind of like comparing this year's Christmas season with last year's Christmas season, only last year the entire country was snowed under and no one could get out and shop.
Most of Morgan's good numbers were good in comparison with last year, but down slightly in comparison with last quarter. That's not terrible, but it does blunt the good news somewhat. A year-by-year comparison over the past four years shows that the third quarter EPS can be a bit weak, but nothing like Q3 1998. A more realistic way to report the good news might have been, "Best third quarter performance in the last X years." (X is at least four, but I don't have data farther back that that.)
Better news for Foolish Four investors is that the company also announced that they plan to increase quarterly dividends by $0.01, from $0.99 to $1.00. That would boost the annual dividend to $4.00. (This new figure won't show up at Strategy Stocks Live until the new dividend rate is officially declared at a Board of Directors meeting in December. Today's announcement was a statement of intent, not an official dividend declaration, although it would take a major financial crisis to cause the BOD to fail to follow through on its announced intention.)
But maybe what was driving today's rise was neither the profits nor the dividends increase. The profits exceeded analysts' expectations, but not by that much, and a 1% increase in the dividend isn't exactly world-shattering. And, remember, we still have that possible interest rate hike hanging over the market, especially over financial stocks.
I think that a big factor was the announcement of JP Morgan's plan to buy back up to $3 billion dollars worth of its outstanding stock. When a company announces its intention to buy back its own stock, that does two things.
First, it signals that the company considers its stock to be a very good buy. And who should know better than they? They don't have to buy their own stock, after all. JP Morgan could buy Citigroup or American Express if they thought it was a better deal. They could buy Amazon.com. They are saying that they think their stock is one of the best deals going.
Second, buying back their own stock is also a great way to increase shareholder value. With a market cap of around $18 billion at the time of the announcement, a $3 billion dollar buyback represented 16% of outstanding shares. Buying those shares back is a tremendous boon to shareholders. If it could take place immediately, it would have the effect of increasing earnings per share (EPS) by 16%, which would -- theoretically at least -- increase the value of each share by a corresponding percentage.
Buying back stock is like cutting the pie into larger pieces than you expected. You sit down at a lunch counter and see a pie cut into eight pieces. You order a slice. But surprise, you are served from an identical pie that has been cut into six equal pieces instead -- for the same price. How lovely. (Warning: I'm exaggerating the size of the buyback in my example. They don't normally cut pies into small enough pieces to make the percentages work. I guess I could have used sheet cake....)
Unfortunately, the buyback can't take place immediately. It isn't logistically possible to place an order for 28 million shares of a single stock -- that's more than 20 times the number of shares that trade each day -- nor would it be financially wise. That kind of demand would send the price soaring, but only until the demand was filled. When companies buy back their own stock, they do so very gradually. In this case, the intention is to buy back shares over the next 12 to 18 months.
We will see the effect of the stock buyback in future earnings releases. As the total number of shares outstanding decreases, the EPS pie can be cut into larger pieces, and the dividends pie will likely be cut into larger pieces, too.
Ummmm, ummmm.
Fool on and prosper!