Although the takeover carries a fair amount of risk for JPMorgan, the bank looks increasingly likely to emerge as a credit crisis survivor. They still have a “reasonably strong” balance sheet and have by and large managed to steer clear of a debacle of historical proportions.
How did this come about? Also, are there elements to this story that you as an individual investor can learn from?
Fortune recently published a comprehensive account of how JPMorgan mostly avoided the subprime debacle (“Jamie Dimon’s Swat Team”), which is well worth a read. Based on the article, I have tried to summarize the main principles that have so far kept JPMorgan as a company out of trouble.
These principles are, in my opinion, just as valid on a personal level when you, as an individual investor, are to decide whether or not a company stock is a good buy. So, I have also tried to relate each principle to general best practices of investment.
1. It’s all in the numbers
In early 2006, JPMorgan were, like everyone else, dealing in subprime CDOs. By the end of that year, the bank had dumped more or less all of their subprime mortgage holdings. What happened?
First of all, the numbers were no longer looking good.
JPMorgan has a strong tradition of data-mining every aspect of their business and continuously trying to figure out the story behind the numbers. What Jamie Dimon, the CEO, and his team saw was that the subprime market was way to risky for the profits it was generating. Data from their retail banking division showed that subprime loan payments were increasingly late. Moreover, their own data analysis indicated that the supposedly safe AAA ratings lavished upon CDO bonds were bogus.
The numbers were increasingly and consistently negative and in sharp contrast to the conventional wisdom on the subprime market. Trusting the data and its interpretation rather than the general opinion, JPMorgan left the market altogether.
When evaluating a company as an investment opportunity, you can rely on a barrage of opinion from a sea of sources with a multitude of motivations.
Or, you can go straight to the facts.
The numbers in quarterly reports or annual accounts don’t lie unless deliberately tampered with. If the balance sheet tells you that a company is heading for trouble, then that company is heading for trouble, no matter what anyone else might be saying.
- Learn how to read and understand the balance sheet, the income statement and the cash flow statement. Once understood, they tell you more about the company than any financial advisor or industry analyst ever will.
- Be diligent in your pursuit of data, both on the company, the sector, and the general state of the economy.
- Read the numbers first and then make up your own interpretation. Other people’s interpretations are not gospel, but rather a challenge to your own interpretation.
- The opinionated parts of a company’s annual report are mostly fluff and should be read as such. Read the annual report from the back. It’s not a crime to talk about a company in optimistic terms; manipulating the numbers is.
2. Investment is not about short-term profit
JPMorgan exited the subprime market while it was still a booming business. This took a lot of guts when other Wall Street firms were making a killing from subprime.
In the short term they lost ground to competitors by not jumping on the latest Street bandwagon. Their conservative stance and the effect it had on quarterly earnings must have generated immense pressure, both internally and externally. From 2005 to 2007, JPMorgan fell from third to sixth place in fixed-income underwriting. This is the sort of development that causes ruckus in board meetings.
Nonetheless: In the long term they prevailed.
Their decision to trust their analysis of subprime being too risky turned out to be a sensible one, even if this meant a very negative short-term impact on their balance sheets.
By focusing on core company values rather than pursuing immediate profit, JPMorgan emerged on top.
You can certainly make money from overhyped stocks whose valuation belies the true worth of their business. This, however, requires you to play the game of getting out before the bubble of irrational exuberance pops.
Timing the market is ultimately about luck. Luck is a property that is best reserved for the lottery rather than your savings.
Fashion does not imply quality. Just because everyone else is ecstatic about something—be it dot-com companies or the mullet—does not mean you should be as well. Only get with the crowd if there is a fundamentally sane reason for doing so. Dare to be different.
- Be prepared to stick it out as long as the underlying fundamentals of your analysis does not change. Quality always prevails in the long term.
- Even fundamentally good stocks go down if they are unpopular. This is the way the market rolls; don’t lose any sleep over it.
- You will not be able to consistently time the ups and downs of the market, so don’t even try to. Learn to live with the fact that good stocks will sometimes go down for no good reason.
- Don’t check your portfolio every five minutes. Apart from keeping you from getting any other work done, it will only lead you to perceive the market as more volatile than it really is. Think the market is too volatile? Just reduce your sampling frequency. Remember that you are in it for the long run.
- Listen to other people but don’t let them make your decisions. Even if they have a compelling chain of arguments there are likely more conclusions that can be drawn from the same set of underlying facts. Your explanation of why to invest should always be your own.
3. Question and diversify
JPMorgan operating-committee meetings are described as “loud and unsubtle”. According to Bill Daley, head of corporate responsibility and former Secretary of Commerce, “[p]eople were challenging Jamie, debating him, telling him he was wrong. It was like nothing I’d seen in a Bill Clinton cabinet meeting, or anything I’d ever seen in business.”
This culture of allowing, encouraging and listening to dissent ultimately made it easier for JPMorgan to make the right decisions. Getting all facts and viewpoints on the table while continously questioning what they were doing was a major success factor.
Still, JPMorgan made their own share of mistakes.
In 2007 a short-term secured loans unit bought a $2 billion subprime CDO—upper management claims they never knew. Other billion-dollar write-offs had to be endured as well. Their principle of only taking risks when you are paid well for doing so is anything but perfect. It also remains to be seen how well timed their shotgun purchase of Washington Mutual turns out—among its assets are an estimated $30 billion’s worth of loans that have to be written down. However, on the whole they look to be emerging from the credit crisis as a much healthier company than their surviving competitors.
There is no such thing as a risk-free investment, so be prepared to accept losses. JPMorgan’s competitors put themselves in a position where some of them could not weather a downturn in one of their business segments. JPMorgan, on the other hand, were doing what they could to make sure their good moves outweighed their bad moves.
Making bold investment choices always carries the probability of failure. Use diversification as a cushion for when failure strikes.
In bicycle racing, one does not talk in terms of if a rider will take a tumble but rather about when. The same should apply to your investments.
Moreover, be prepared to continuously question your own judgment. The premises for earlier decisions will change, so be prepared to revert on them. If faith becomes a stronger motivation than reason for holding on to stock it’s probably time to let go.
- Hedge your investments. No matter the soundness of your strategy or how diligently you stick to your principles, things will still go wrong from time to time. Don’t allow mishaps to take you down.
- Be prepared to change your position. Things change, the world keeps turning, and so should you.
- Don’t get emotional about a stock. Your favorite company might turn from making mostly good decisions to making mostly bad decisions. These things happen, so be prepared to get out even if this means taking a loss.
- If your sole reason for hanging on to a stock is the belief of future recovery then you have already lost. Get rid of it, count your losses, and learn from the experience.