Earnings: JPM, C, GS Beat Estimates—But Are They Good Buys?

October 15, 2009

Yesterday’s announcement from JPMorgan Chase (JPM) that it obliterated estimates sparked a buying party on Wall Street that pushed the Dow above the Holy Grail of index levels (10,000). But the bulls backpedaled today after Citigroup’s (C) earnings report gave investors a real taste of the trend that is likely to dominate banks’ third-quarter announcements—namely, failed consumer loans.

What to Look for from Banks this Earnings Season

JPMorgan’s earnings beat really isn’t a surprise at all. This investment bank has a great track record of trouncing expectations. For one, JPMorgan always had sufficient capital under its belt during the credit crisis, which helped the company suck up its weaker rivals. To this day, Bear Stearns leaves a sour taste in the mouths of most investors. But it is the demise of this very company—along with Lehman Brothers, Washington Mutual and Merrill Lynch—that has JP Morgan Chase chomping on the heartiest slice of the financial market.

After snatching up market share for pennies on the dollar, the company returned to profitability in late 2008 and has grown earnings every quarter of this year—including a 600% earnings surprise in Q2 and a 58% surprise in Q3.

JPM’s better-than-expected third-quarter results and higher guidance really raised the bar for everyone else in the industry. But a closer look at the numbers from JPM’s latest quarterly report reveals the challenges still facing most financial institutions today—namely, soured consumer loans. The investment bank said that its non-performing assets (or loans that are at least three months past due) more than doubled in the third quarter from the year-ago period to $20.4 billion. JPM’s total credit reserve now stands at $31.5 billion.

The Consumer Is Still Broken

Lingering bad debt from subprime mortgages and consumer credit loans continue to weigh heavily on the balance sheets of most financial companies. My tempered enthusiasm regarding the earnings outlook for financial stocks stems from the simple fact that banks all around the globe are still setting aside hundreds of billions of dollars to protect their bottom lines from bad loan losses.

Even JPM isn’t sheltered from poor consumer credit. This begs the question: How have the company’s investment banking counterparts fared? Transparency from banks like Citigroup (C) and Bank of America (BAC) is especially important this earnings season, and frankly, the outlook for some of these companies leaves much to be desired.

Stay Away from C

Personally, I wouldn’t go near Citigroup with a 10-foot pole. Today’s earnings report provided investors a sobering reminder that the banking giant is still being anchored down by billions of dollars in failed loans. Like JPM, C added $800 million to its loan loss reserves during the quarter. This is down $3.1 billion from the addition it made in Q2 but indicative of the fact that consumers are still overwhelmed.

The company’s earnings beat in the second quarter had more to do with a one-time multibillion-dollar gain associated with the sale of one of its assets. I suppose if Citigroup could grow brokerage houses on trees and sell them off every three months it would be in good shape. But absent another massive one-time windfall, things are looking far less rosy for this company.

BAC is Another Dog with Fleas

I’ve always had a difficult time trusting the legitimacy of Bank of America’s earnings reports, especially under the direction of Ken Lewis who always seemed to find a way to massage the numbers. Now that Lewis is out of the picture, investors are about to get a clear view of BAC’s bottom line. If fundamentals say anything about a company, then Wall Street could be in for a rude awakening on Friday when BAC announces its latest results. Right now, analyst estimates range from a 42-cent loss per share to a 1-cent profit, with the consensus falling somewhere around -$0.21 per share. But as with C and JPM, it’s safe to expect BAC to dramatically increase its reserves to cover further credit losses.

The Takeaway

Investing in financial stocks may not be the gamble it was just one year ago, but as far as fundamentals are concerned, the risks still outweigh the rewards. Today we learned that Goldman Sachs (GS) squashed estimates in the latest quarter—as a behemoth on Wall Street, GS has managed to stay successful in both good times and bad. But this industry titan is an exception to my general rule of thumb: Very few—if any—financial companies are great growth stocks right now. Until consumers start repaying their loans, there will continue to be a lot of uncertainty in this sector.

---

Wouldn't it be great if there was a way to get a clear and accurate picture about a company's health and how it might affect the future price of its stock? I have news for you—there is. My FREE stock-rating tool, Portfolio Grader, puts you in control of your investments. With just a few simple clicks of the mouse, you can have all the information you need right at your fingertips. Learn, assess and invest in the fastest-growing stocks—sign up FREE today!