JPMorgan’s increasing returns

Unlock the Editor’s Digest for free

Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Good morning. Late last week Goldman Sachs released a report comparing today’s biggest, best-performing stocks to the big names from the 90s tech bubble and the “Nifty 50” stocks of the 70s. They found that the standout stocks today are at much cheaper valuations than the stars of the 90s were, and while the valuations of the Magnificent 7 et al do look a lot like the “Nifties,” they tend to have significantly higher return on equity. They also found high performance concentration in the index was not associated with subsequent declines.

This chimes with Unhedged’s house view. While stocks sure do look expensive, the market is well short of being properly bananas; but if you expect stock returns to be anywhere near as high in the next 10 years as in the last 10, you are properly bananas. See it differently? Email us: robert.armstrong@ft.com and ethan.wu@ft.com.

How did JPM become so dominant?

We spend a fair amount of time around here thinking about increasing returns to scale, and how that drives winner-takes-almost-all dynamics, particularly in the tech industry. Listening to a recent FT Behind the Money podcast about JPMorgan Chase, however, made me wonder if banks might not be the most interesting and perhaps even the most extreme example of that dynamic. JPM towers over the banking industry like the Colossus of Rhodes. 

Consider profits first. This chart shows the 2023 net income of all 163 US banks with market capitalisations greater than $500mn. The names are small and mush together illegibly, but it’s the gestalt image that matters here. JPM is all the way to the left:

Last year JPM earned twice as much as the second place bank (Bank of America), 24 times as much as the 10th largest bank (Regions) and 73 times as much as the 20th largest (Zion).

JPM is not just exceptionally profitable. It also just owns the most stuff. The dispersion of assets in banking is almost as extreme as the dispersion on profits:

While JPM has only 20 per cent more assets than its nearest rival, Bank of America, it has 18 times the assets of First Citizens, the tenth-largest bank. Stock returns may tell the story best of all. In a 20-year period that has been lousy for banks generally, JPMorgan has kept up with the S&P 500 and, recently, beaten it. There are only a handful of bank stocks that have outperformed JPM’s, and they are all much smaller (note that the performance of the KBW bank index, an index of 24 large US banks, would be even worse were JPM not some 8 per cent of it):

There is at least one obvious reason why size should be helpful in banking: to a degree, it is a fixed-cost business. Administrative and technological costs should not grow one-to-one as assets grow, leading to wider margins. That said, one might not have guessed that banking would have quite such a winner-take-all structure. To the degree that banking is the business of distributing money — gathering capital at one price, lending it at another — it is a commodity business. The cost of goods sold (the price paid for the money) should not fall all that much as scale increases.

The incredible dominance of JPM raises a lot of interesting questions, then, including:

1. Just how much of JPM’s dominance is down to increasing returns to scale?

2. How much of it is down to skilled management: risk management, strategic direction, and so on?

3. How much has the post-crisis regulatory regime helped JPM dominate its peers, for example by increasing the fixed cost of regulatory compliance?

4. How much have JPM’s recent large acquisitions — Bear Stearns, Washington Mutual, First Republic — contributed?

5. Has banking industry profit always been so concentrated?

6. Is it a good thing for the economy in general that one bank should tower over the industry? Should America want more big banks? Less? 

7. Is JPM’s run likely to continue? Is it set to become more dominant still, and its stock to continue outperforming? 

We’ll try to answer some of these questions in a series of letters in the weeks to come. As a way to start, though, it is worth asking two very basic questions. How has leverage — a key determinant of risk and profitability at banks — changed at JPM over the last 20 years? And how has profitability changed with scale?

The answer to the first question is that — unsurprisingly given the tightening regulatory regime — JPM has not increased leverage over the last 20 years. As measured by the simple and hard-to-game ratio of equity to assets, JPM has bounced around between 11 and 14 for most of that time (that is, equity has been 6-9 per cent of assets, with no clear trend). 

The answer to the second question is that return on tangible equity has not risen in a linear way, even as assets have grown at a muscular compound annual rate of about 8.5 per cent a year. A chart:

There has been a strong trend the last few years, but there is not an apparent linear relationship between size and returns. A return on assets chart looks broadly similar.

Banks, like many other businesses, often face a choice between high returns and high growth. We might therefore think of JPM’s dominance in terms of its ability to grow assets and equity quickly while maintaining high returns, and not cracking up along the way. Among large banks, only Wells Fargo has grown assets as fast over the past two decades, and its growing pains are well known. Some regionals have grown faster, but off much smaller bases. So the question about JPM’s dominance might be a question about how size begets size, and how to manage that process. 

More on this in days to come. Meanwhile, we are keen to hear your thoughts on America’s biggest bank.

One good read

The Pettis-Foroohar-Baldwin-diPippo-Setser globalisation debate as summed up by Sankaran.

FT Unhedged podcast

Can’t get enough of Unhedged? Listen to our new podcast, hosted by Ethan Wu and Katie Martin, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.