Is This the Best Bet in Banking?

There is a lot to like about JPMorgan Chase. It's arguably one of the nation's best banks, run by one of the best bankers of the era, Jamie Dimon.

In the second quarter, JPMorgan earned 14% on its tangible equity. Dimon has suggested that some revenue growth and cost cuts could put the bank on track to reliably earn 15% or more on its tangible equity over the next few years.

And despite this strong performance, investors are letting shares trade for less than 1.5 times tangible book value, a relative steal compared to the 2.3 times tangible book valueshares of Wells Fargoare trading for.

Upping your returnsWhat makes JPMorgan most interesting to me is that there is a very cheap way to leverage your exposure to the upside in the stock by buying its TARP warrants. JPMorgan warrants expire on October 28, 2018, and currently enable their owners to buy a share of the bank at $42.33 each.

In effect, investors who buy the warrants today get added leverage in their investment with virtually zero premium to do so.

Source: Investor relations.

At the time of writing, JPMorgan shares trade for $67.55, just two cents lower than the breakeven price that shares need to trade for by October 28, 2018, for the warrants to be profitable.

If you happen to think JPMorgan is an excellent bank trading for a very fair price, it's hard not to like the advantage of the warrants, which give you more leverage to its performance with essentially zero additional cost. Over time, as JPMorgan makes bigger dividend payments to its shareholders, the exercise price of the warrants will only come down, as it has in recent history.

A little more than three years from today, when the warrants expire, it wouldn't be far-fetched to think that JPMorgan could maintain its valuation of roughly 1.5 times tangible book value on $55 of tangible book value per share, up from $46.13 in tangible book value per share today. That would imply a valuation of $82.50 per share by October 2018, resulting in a nearly 60% return on the warrants compared to a 22% price return from the common stock.

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Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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