JPMorgan Chase Stock Upgraded: What You Need to Know

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

From peak to trough, shares of JPMorgan Chase & Co. stock tumbled 9% in the first two weeks of February. The rebound in markets we've seen over the past couple days has helped to repair that damage, cutting JPMorgan's stock losses in half -- but according to one analyst, there are even more gains in store.

With JPMorgan stock still down 5% from its high at the start of the month, banking analyst Keefe, Bruyette & Woods says there's still time for investors to "upgrade quality" -- to sell lower-quality banking stocks, and to buy JPMorgan stock instead.

Here's what you need to know.

Upgrading JPMorgan

"We believe the market is pricing in a scenario for bank stocks, and JPM, that is overly pessimistic given our expectations for the macroenvironment near term," says Keefe Bruyette in a note covered on StreetInsider.com (subscription required) this morning.

"[M]acro risks" such as the potential for jobs growth to raise wages -- and inflation, along with rising bond rates that could entice investors to sell dividend stocks, "have increased" admits Keefe Bruyette. But in the analyst's view, "[I]t is when risks are increasing that we would expect higher-quality bank franchises -- such as JPM -- to outperform."

Seeing JPMorgan stock fall instead of rise, therefore, looks like an opportunity to Keefe Bruyette, and it's responding by upgrading JPMorgan stock to outperform and assigning the $112 stock a price target of $127.

How much is quality worth?

Let's assume for a moment that Keefe Bruyette is right about JPMorgan. In that case, what price is right for JPMorgan stock? According to the analyst, at today's prices, JPMorgan is selling for about 11.3 times the profits the analyst expects the company to earn in 2019, which is of course two years from now.

That's a long way to toss a crystal ball, though. Based on more reliable data -- trailing earnings -- JPMorgan costs a somewhat pricier 17.7 times trailing earnings, which is kind of middle of the pack for big banks. On a P/E basis, JPMorgan stock is undeniably cheaper than Bank of America, which costs 19.8 times earnings, or Goldman Sachs, which sells for 27.8 times earnings -- and unprofitable Citigroup has no P/E to speak of. On the other hand, JPMorgan is not cheaper than Wells Fargo, which sells for just 13.9 times trailing earnings.

Is quality quantifiable?

That being said, it's open for debate whether JPMorgan really is the best-quality bank for the money. Here's how it stacks up relative to its peer "too big to fail banks" for returns on equity and returns on assets -- two common measures for examining a bank's quality -- and on projected earnings growth rates:

As you can see, JPMorgan does in fact outclass most of its rivals on both ROE and ROA. But what they lack in low returns historically, JPMorgan's rivals may make up for in growth prospects going forward -- and for forward-thinking investors, that's also important. For that matter, according to analysts who follow these stocks at least, the one bank that does edge out JPMorgan on quality metrics, Wells Fargo, also has a slight edge on growth.

Final point

Still, Keefe Bruyette has a point. Wells Fargo may be a slightly better bank than JPMorgan Chase, and it may be growing faster, but Wells Fargo also retains a fair whiff of scandal about it. That's harder to quantify than return on equity, and to my mind, it may be a good reason to exercise caution about investing in Wells Fargo based on its superior numbers alone.

Given Wells Fargo's reputational risk, the safer play may actually be to buy JPMorgan stock instead -- just as Keefe Bruyette is advising. When a top-10% analyst with a 68% record for accuracy in the commercial banks sector speaks, it pays to listen.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.