Investment Strategy - Essay Example

Investment Report Executive Summary The investment idea can generally be classified into ‘turnaround’ or ‘short-sale’ investment strategy. The former strategy focus on particular sector or stocks that are currently not attractive to other investors. Another strategy is the concept of ‘shorts’ the analyst study the trends in stock movements. The key to success in this strategy is to identify the peak of stock when buyers are buying and prices are appreciating. This investment report is based on JPMorgan Chase & Co. (Ticker: JPM) that thoroughly analyzes critical aspects including sentiments, management, balance sheet, fundamentals, technical, valuation to determine investment decision. The investment idea was ‘shorts’. Market sentiments are positive for JPM and investors are expecting share prices of JPM to appreciate with the trending market movements. The detailed observation and evaluation by the Chairman and CEO is discussed in the annual report of the company under the “Management Discussion and Analysis” section. Both of them has concluded that internal control and procedures were effective during financial year 2013. The financial statement of the company aims to provide information about enterprise’s financial position on a given date. Technical analysis involves identification patterns or trends in the movements of stock prices at an earlier stage and then device an appropriate strategy with the objective to benefit from such market movements. The technical of JPM suggest that its stock prices are currently experiencing up-trends. A bullish market sentiment and better job creation report along with better economic growth could be probable reason for the same. Contents Executive Summary 1 3 Introduction 4 Sentiments 5 Management 6 Balance Sheet 6 Fundamentals 8 Technical 10 Valuation 12 Conclusion 12 Recommendations 13 References 14 Appendix 15 Table 1 – Balance Sheet 15 Table 2 – Financial Ratios 17 Table 3 – Valuation 18 Introduction The investment decision of an individual depends on certain factors like economic conditions, return on investment, attractiveness of security, time horizon, and business outlook. An investor has the option to invest his/her savings in stock markets which provides an opportunity to maximize returns by identifying market trends. The investment idea can generally be classified into ‘turnaround’ or ‘short-sale’ investment strategy. The former strategy focus on particular sector or stocks that are currently not attractive to other investors. The technical chart of such stocks reveals that they are sellers’ favorite and are probably oversold at the moment. The key to success in ‘turnaround’ strategy is to observe the chart very carefully and determine whether the worst is over or not. By analysing the fundamentals of the underlying asset, the analyst could tell whether the stock is left for dead or a possible turnaround is apparent in near future. If such turnaround is expected then investor can buy at cheap valuation and when the stock actually turnarounds then he/she can make profit by selling at higher price. Another strategy is the concept of ‘shorts’ the analyst study the trends in stock movements. The key to success in this strategy is to identify the peak of stock when buyers are buying and prices are appreciating. The moment the analyst discovers that stock is over-valued and holding the stocks in future could lead to losses, the analyst will sell or short the stocks and book profit by selling stocks at premium. The objective of this report is to conduct investment analysis on JP Morgan Chase & Co (Ticker: JPM) and identify whether the stocks are over or undervalued. The report is based on investment idea of ‘Shorts’. Sentiments Market sentiments arise due to emotions of common investors as the market is composed of people who put their money into the markets with the expectation of making profit. Consequently, any distressful news in the market will create a panic in the market and investors generally try to exit investment as soon as possible so as to minimize the impact from financial losses. Alternatively, when the market sentiments are ‘bullish’ or positive, there is a general tendency among investors to get a share of profit from rising market. The analysis of investors sentiments is all about getting an idea regarding about the ‘Next Big’ movement in stocks. The identification of market sentiments requires good knowledge of economics and behavioral finance. The sentiments are important for the traders who want to maximize their profits from movements of stock price. Some of the important factors that drive market sentiments are: Quarterly and Annual earnings call by companies Job market data Periodic GDP numbers Monetary policy reviews Depreciation or appreciation of home currency with respect to foreign currency The key factors discussed above has the potential to trigger a short to medium term bull or bear runs in stock markets. the task of the analyst is to get an idea regarding how the particular stock will react upon trigger of such critical events. This will help the analyst to make important investment decision regarding whether to enter or exit the markets. Management The annual report of JPM reveals all the necessary information internal controls and management of the group. The company was found to carry out an evaluation of internal procedures under the supervision of the Chief Executive Officer and the Chairman. This is a mandatory requirement under the Rule 13(a)-15(e) of Securities Exchange Act, 1934 (Edgar, 2012, p.24). After the global financial crisis of 2008 the banking standards popularly called Basel III has recommended and approved stricter capital adequacy norms to protect the bank from insolvency. The group is committed to maintain high standards of internal control and transparent financial reporting standards. The management has also admitted that considering the size of firm, its internal processes are very complex and no concrete assurance can be given about the deficiencies and lapses in internal controls and the investor should evaluate the financial position of the firm independently before making investment decision. The lessons learnt from the global financial crisis cautions the use of mortgage based securities. The group had reported losses arising from mortgage during 2010 worth $216 millions. But in 2011 the group reported a pre-tax income from mortgage productions worth $993 million. In contrast the mortgage servicing reported pre-tax income of $1.2 billion in 2010 which further declined to net losses of $3.8 billion in 2011. The management identifies that losses were triggered from factors such as higher management fee, high retail cost required to connect branch networks to provide services to customers. Balance Sheet The key items of balance sheet are total assets, current assets, current liabilities, and shareholders’ equity. These items are discussed as follows: Total Assets Assets are financial resources having value that is owned by a business entity and can be readily converted into cash as per requirement. In respect to business, assets are resources that companies employ in order to operate on resources and generate earnings. Assets add value to business and help the company to secure finance when it requires it. Assets may be in tangible (goods which can be seen or felt such as land, money, stocks, etc.) or in-tangible (immaterial aspects such as goodwill, client relations, innovation and patents, employee knowledge, etc.). The total assets of JPM was $27,016 million in the year 2010 and it increase at a compounded annual growth rate (CAGR) of 8.91 percent to $34,902 million in 2013. Current Assets All types of assets do not have same liquidity. For instance, the liquidity of land is much less than inventory. Current assets are those assets which have high liquidity can be readily converted into cash in short time interval. The most liquid current asset is cash and cash equivalents while the least liquid current assets is the inventory. The current assets facilitate short-term borrowings and are very important factor for managing working capital. The current assets of JPM was $965,881 million in the year 2010 and it increase at a compounded annual growth rate (CAGR) of 6.57 percent to $1,169,153 million in 2013. Current Liabilities The current liabilities represent short-term obligations which has maturity of less than a year. Items like bills payables, short-term loans, accrued expenses, accrued payables, etc. constitutes current liabilities. The current liabilities of JPM was $1,593,197 million in the year 2010 and it increase at a compounded annual growth rate (CAGR) of 6.57 percent to $1,928,385 million in 2013. Shareholders’ Equity The total assets less total liabilities represents the true net-worth of the owners in a business as on a given date which is also known as the shareholders’ equity. It arises from two primary sources namely owners’ fund or equity capital and retained earnings accumulated from net profit over period of time. While the former source is original contribution of shareholders in form of paid-in capital the later generally constitutes largest share in normal course. The balance sheet of JPM reveals that the total net-worth of JPM was $176,106 million in the year 2010 and it increase at a compounded annual growth rate (CAGR) of 6.24 percent to $211,178 million in 2013. Fundamentals Accounting ratios have immense application in interpretation of financial statements by helping perform both intra-firm and inter-firm comparison. Financial ratios are generally derived from financial statements of the company which includes published income statements and balance sheet of the company. In order to assess the overall business and financial risk of both the companies as well as its performance fundamental analysis using various types of ratios like liquidity, profitability, solvency, etc. may be conducted on the financial statements of both companies. Profitability These ratios measure the company’s ability to generate earnings relative to assets, sales or equity and thus highlight how effectively the company is being managed. It is a key indicator of the company’s performance in its industry of operation and also helps to measure the company’s financial position. These ratios are mainly derived from the income statement of the company. The indicators of profitability are return on asset (ROA) and net profit margin ratios. While the ROA has remained constant during 2010 to 2013 the net margin of JPM declined from 0.20 in 2010 to 0.19 in 2013. Solvency These types of ratios measure the company’s ability to honor its long term obligations or debt servicing capacity. Thus, it gives an idea to the investor regarding the business and financial risk of the company by analysing the leverage in the company’s capital structure. Very high values of the ratios are considered as risky and it implies that capital structure is highly leveraged. The financial statements of JPM reveals that the company was able to maintain a constant debt-to-equity ratio between 2010 to 2013. Liquidity The liquidity ratio help to evaluate the firm’s ability to honor its short-term or current obligations. It is an indicator for the measure of working capital management. The firms’ short term obligations include carrying out day to day operations, payments to creditors for purchase of raw materials, payment of daily wages of laborers, outstanding expenses and bills payables, etc. Generally, the higher the ratios the liquid the firm would be. The financial statements of JPM reveals that its current assets constitutes 61 percent of current liabilities. Efficiency It is also known as the activity ratios and helps to determine how efficiently a company utilizes the assets and liabilities of the organization. These ratios are very useful when the performance of a particular company is compared to its competitors. The significance of efficiency ratio is in the fact that when the ratios improve over time it implies that the company’s profitability is also improving. The ROCE (return on capital employed) of JPM was very small compared to other companies operating in same industry. The return on net-worth of shareholders of JPM was positive however the value declined from 0.10 in 2010 to 0.09 in 2013. Technical The basic concept of technical analysis is identifying trend reversal at a prior stage and then makes profits from these market movements. Thus, if the investor is to identify particular stocks which are currently trending and then include such stocks in portfolio of assets, technical analysis is almost 60 percent complete. For instance, if there is any clear signal that stock prices are showing ‘up trend’, then the investor will just have to buy the stocks at early stage and then book profits when stock prices reach historic highs or target price. The converse theory is also applicable when the stock prices show down trends. Modern indicators like chart analysis (Bar chart, Candlestick, line, etc.) and chart patterns (head and shoulder, cup and handle, etc.), auto correlation analysis, moving averages, RSI, ROC, and so on, are widely used by technical analysts to understand the stock market trends. The ‘Candle Stick’ chart may be considered as an extended version of bar charts. They rely on colors to explain what happened during trading period. This chart helps to identify a shares’ open, close, low, and high. The vertical axis plots share price while the horizontal axis plots time period. If the open price of stock exceeds close price, the candle stick body is black. When the close price exceeds open price, the candlestick body is white. The thin vertical line is called ‘wick’ and the thick portion is called the ‘body’. They are used to summarize price data, helps identifying trends, and helps to understand certain patterns easier to recognize. (Source: Yahoo Finance, 2014) The current market movements at present is guided by two major factors namely- i) The monthly job report, and ii) Monetary policy of US FED (Federal Reserve System). The US economy reportedly generated 175,000 jobs by the end of February 2014 despite inconsiderate winter. Better employment numbers, higher growth in first quarter of 2014 has created a bullish sentiment in the Wall Street and this is also reflected in stocks of JPM which is currently experiencing up-trends since February 2014. However, the stocks of JPM is very close to its 52 week high of $59.82 (as currently stocks are trading at $58.90 as on March 8, 2014). Valuation The 52 week range of JPM is between $46.05 and $59.80. The average trading volume of JPM is 18,615,141 and the current market capitalization is over $223 billon. The P/E multiple of the company is 13.66 and EPS is $4.35. The rising trends in share price is an opportunity for short selling and thus many analysts expects the stock prices of JPM to trade at premium and given target price of $65.45 (Yahoo Finance, 2014). The valuation of JPM will reveal its intrinsic value and suggest whether the stock is over- or undervalued. The stock price valuation of JPM reveals that its intrinsic price is $53.55 and it is currently trading around $58.90 (as on March 10, 2014). This means the stocks of JPM are overvalued. Conclusion This investment report is based on JPMorgan Chase & Co. (Ticker: JPM) that thoroughly analyzes critical aspects including sentiments, management, balance sheet, fundamentals, technical, valuation to determine investment decision. The investment idea was ‘shorts’. Market sentiments are positive for JPM and investors are expecting share prices of JPM to appreciate with the trending market movements. The detailed observation and evaluation by the Chairman and CEO is discussed in the annual report of the company under the “Management Discussion and Analysis” section. Both of them has concluded that internal control and procedures were effective during financial year 2013. The financial statement of the company aims to provide information about enterprise’s financial position on a given date. Such information helps the decision makers like potential investors to strategize correct course of action. The decision makers may be internal (such as shareholders, management, employees, etc.) or external (suppliers, creditors, government, competitors, etc.) to business enterprise. The ratio analysis reveal that financial position of JPM is stable and predictable. Technical analysis involves identification patterns or trends in the movements of stock prices at an earlier stage and then device an appropriate strategy with the objective to benefit from such market movements. The technical of JPM suggest that its stock prices are currently experiencing up-trends. A bullish market sentiment and better job creation report along with better economic growth could be probable reason for the same. Recommendations The intrinsic share price valuation reveals that company’s stocks are currently overvalued. Many analysts have also given it a 11.12 percent premium target price ($65.45) based on current market price $58.90. However, the intrinsic value is $53.55 and hence the best investment idea is to short sell shares of JPM and maximize profits. References Yahoo Finance. (2014). JPMorgan Chase & Co. (JPM): Technical Analysis. Retrieved from http://in.finance.yahoo.com/q/ta?s=JPM. Edgar. (2012). JPMORGAN CHASE & CO FORM 10-K (Annual Report). Retrieved from http://files.shareholder.com/downloads/ONE/3006083475x0xS19617-13-221/19617/filing.pdf. Appendix Table 1 – Balance Sheet Balance Sheet of JPMorgan Chase & Co.   2010 2011 2012 2013   Currency in Millions of US$ Assets         Cash and Equivalents $ 27,016 $ 55,516 $ 49,006 $ 34,902 Trading Asset Securities $ 489,892 $ 443,963 $ 450,028 $ 374,664 TOTAL CASH AND SHORT TERM INVESTMENTS $ 764,530 $ 822,775 $ 919,044 $ 974,343 Restricted Cash $ 803 $ 4,400 $ 5,600 $ 5,300 Loans Held for Sale $ 5,453 $ 2,626 $ 4,406 $ 12,230 Other Current Assets $ 123,587 $ 142,462 $ 119,017 $ 111,465 TOTAL CURRENT ASSETS $ 965,881 $ 1,034,587 $ 1,109,684 $ 1,169,153 NET PROPERTY PLANT AND EQUIPMENT $ 13,355 $ 14,041 $ 14,519 $ 14,891 Goodwill $ 48,854 $ 48,188 $ 48,175 $ 48,081 Other Intangibles $ 4,039 $ 3,207 $ 2,235 $ 1,618 Other Long-Term Assets $ 95,193 $ 95,729 $ 93,332 $ 101,937 TOTAL ASSETS $ 2,117,605 $ 2,265,792 $ 2,359,141 $ 2,415,689           LIABILITIES & EQUITY         Accounts Payable $ 74,971 $ 81,542 $ 86,842 $ 78,100 Accrued Expenses $ 95,359 $ 121,353 $ 108,398 $ 116,391 Short-Term Borrowings $ 415,551 $ 362,048 $ 152,659 $ 320,265 Current Portion of Long-Term Debt/Capital Lease -- -- -- $ 45,434 Other Current Liabilities, Total $ 76,947 $ 66,718 $ 61,262 $ 80,430 TOTAL CURRENT LIABILITIES $ 1,593,197 $ 1,759,467 $ 1,602,754 $ 1,928,385 Long-Term Debt $ 304,987 $ 284,063 $ 499,874 $ 220,884 TOTAL LIABILITIES $ 1,941,499 $ 2,082,219 $ 2,155,072 $ 2,204,511 TOTAL PREFERRED EQUITY $ 7,800 $ 7,800 $ 9,058 $ 11,158 Common Stock $ 4,105 $ 4,105 $ 4,105 $ 4,105 Additional Paid in Capital $ 97,415 $ 95,602 $ 94,604 $ 93,828 Retained Earnings $ 73,998 $ 88,315 $ 104,223 $ 115,756 Treasury Stock $ (8,160) $ (13,155) $ (12,002) $ (14,847) Comprehensive Income and Other $ 948 $ 906 $ 4,081 $ 1,178 TOTAL COMMON EQUITY $ 168,306 $ 175,773 $ 195,011 $ 200,020 TOTAL EQUITY $ 176,106 $ 183,573 $ 204,069 $ 211,178 TOTAL LIABILITIES AND EQUITY $ 2,117,605 $ 2,265,792 $ 2,359,141 $ 2,415,689 Shareholders' Equity $ 176,106 $ 183,573 $ 204,069 $ 211,178 Table 2 – Financial Ratios RATIO ANALYSIS 2010 2011 2012 2013 A. Profitability Ratios         ROA= Net Income/Total Assets 0.01 0.01 0.01 0.01 Net Profit Margin= Net Income/Sales 0.20 0.21 0.23 0.19 B. Solvency Ratios         Total Debt to Assets Ratio= Total Debt/ Total Assets 0.92 0.92 0.91 0.91 Debt-Equity ratio= Total Debt/ Total Shareholder's equity 11.54 11.85 11.05 11.02 C. Liquidity Ratios         Quick ratio= Current assets - Inventory/ Current Liabilities-Bank overdraft 0.61 0.59 0.69 0.61 Current Ratio= Current Assets/Current Liabilities 0.61 0.59 0.69 0.61 D. Efficiency Ratios         Return on capital employed= Net Income/ Capital Employed, where, Capital Employed=Debt Liabilities + Shareholder's Equity 0.01 0.01 0.01 0.01 Return on net worth or Return on Equity= Net Profit (after interest and tax)/ Shareholders fund 0.10 0.11 0.11 0.09 Table 3 – Valuation Read More