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2024 was a good – very good – year to be a bank. Wall Street thinks 2025 may be even better.
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Transcript46 lines
- [00:00]
Matt Frankel
Foreign.
- [00:05]
Mary Long
The banks are all right. And you're listening to Motley Fool Money. I'm Mary Long, joined today by Matt Frankel. Matt, thanks for joining us.
- [00:18]
Matt Frankel
Hey, always good to be here. It's been a while and you have me like once a quarter. When banks report earnings, it's always fun to talk about.
- [00:24]
Mary Long
I was going to say, when banks report, there is one person that we want to call and that is you, Mr. Frankel. We got a bunch big banks reporting yesterday and this morning. The big headline is that they're doing pretty well. Net income rose 50% at JP Morgan, close to that at Wells Fargo, more than doubled at Goldman Sachs. Citigroup saw nearly $3 billion in profit after posting a net loss of almost $2 billion a year ago. JP Morgan in particular is worth highlighting because they made $58.5 billion in profit last year. That's over a billion dollars a week. Not a bad paycheck. Matt, what are the banks drinking and where can I get some of it?
- [01:06]
Matt Frankel
Well, it's not quite as good as it sounds. One thing that's important to point out, if you remember what was going on in 2023, there was all the bank failures and things like that, and there were a lot of special assessments from the FDIC going on. That was all priced into the earnings that we're seeing in the fourth quarter. It's not a great year over year comparison. In other words, we had billions of dollars of FDIC special assessments. But bank profits are rising. There are some really strong points. Investment banking gives a big growth catalyst. Right now, some banks have investment banking revenue up 30 to 50%. In a lot of cases, we're seeing that really rise. We're seeing trading revenue rise sharply, especially fixed income. In uncertain interest rate environments. You see a lot of fixed income trading going on and there's just a lot that's going right and not that much that's going bad. There were a lot of fears that consumers were going to pump the brakes on spending, that default rates were going to rise in the high interest rate environment and things like that, we're not really seeing that play out as expected. And the investment banking and trading side of it is really kind of bolstering bank earnings.
- [02:11]
Mary Long
I've heard a lot of talking heads and folks in financial media attribute so much of this success to excitement about the incoming administration and how they're likely to make for a less regulated and more deal happy environment. That's something that banks love. My question is, okay, stock prices are tied to future expectations, but These results prove that we're already seeing these companies post big gains. How does, how does that happen? You mentioned kind of the, that it's not totally fair to make a year over year comparison because of things that were happening in the year before this. But if bankers are attributing part of their success to what they're anticipating will come in the future, how are we already seeing such obvious successes in their current earnings?
- [02:52]
Matt Frankel
Yeah, so there's two sides to these bank businesses. There is the investment banking side, which is the one that is responsible for most of the big gains so far. Then there's the consumer banking side, which hasn't really gone up all that much. And the reasons that people are optimistic about the incoming Trump administration are a little different. Just to name one example, banks are very, very prone to taxes. They're one of the most heavily taxed industries in the market. Just for example, Goldman Sachs had an effective tax rate of more than 22% this last quarter. So when you're talking about, you know, doing corporate tax cuts, which the incoming administration has mentioned, banks could be a big beneficiary of that. So that's just one example. But there's also the deregulation makes an easier M and A environment, which also would add even more fuel to the investment banking world as more companies are able to get M and A deals and things like that done in the banking industry itself. We mentioned Capital One, what we were talking before the show, they're planning to acquire Discover this year. It could be an easier time for that kind of deal to go through under the new administration. So there's a lot of future catalysts. But the investment banking side is really what we've seen kind of catapult earnings this quarter.
- [04:06]
Mary Long
We also got some inflation data that was released yesterday. And that adds a little bit of rosiness to this overall picture. Total CPI held relatively steady, but its core cpi, this is a number that excludes more volatile costs like food and energy that slowed for the first time in months. So stocks across the board, banks, yes, but not just banks, reacted really positively to this up this morning. And many a financial media publication can be seen tying those two events together. Why is this inflation report seemingly responsible for setting off a little bit of a frenzy on Wall Street?
- [04:39]
Matt Frankel
So the inflation data actually came in two parts this month. We had the ppi, the Producer Price Index, which is also part of what the Fed looks at, that came on Tuesday. The core PPI was way ahead of expectations, I think 0.3 percentage points, which is a Big surprise. But until the CPI data came out, it was thought that that was a one off, just a sea of some good inflation data in a sea of bad. Then the CPI data came out and confirmed that in December inflation really was less than expected. And the short answer is that faster rate cut better than expected inflation is good for rate cuts. It can encourage the Fed to be comfortable cutting rates faster than expected. And that is a catalyst for almost the entire market. But banks in particular, bank interest margins have been under pressure significantly over the past couple years as interest rates have risen. And if the Fed keeps cutting rates, if they cut more aggressively than expected, it could provide a positive catalyst for bank interest margins as the cost of capital goes down and the yields from their loan portfolios essentially stay the same for now. So it can really help widen the margins.
- [05:49]
Mary Long
Going to focus on fourth quarter trading revenues from three of the biggest players in the bank biz. Goldman reporting net revenues in their equities business of about three and a half billion dollars. Morgan Stanley's equity equities trading business brought in $3.3 billion in revenue. Then you've got JP Morgan. Their investment banking revenue hit 2.6 billion. There's fierce competition between these three banks. As a financials investor, as our go to guy, when we want to talk banks, how much mind do you pay to which of these three is in gold, silver, bronze on the podium? And how do you actually compare their successes side by side?
- [06:27]
Matt Frankel
Yeah, well, I mean this is definitely a case of a rising tide lifts all ships. So think about what was going on in the fourth quarter. There was a lot of trading of volatility in the stock market, good volatility for the most part around the election. So we saw a lot of volatility. A volatile market, whether it's going up, going down, volatility is good for trading revenue in these investment banks. So it's really a rising tide lifts all ship. On the fixed income side, it was really impressive as well. It's really tough to rank those as gold, silver and bronze for me. I look at how they did relative to expectations. For example, Goldman Sachs beat estimates for trading revenue on both equities and fixed income. That wasn't the case for J.P. morgan. They beat on the fixed income side, but not the equity side. So really it's whether or not they surpassed expectations. And trading is the bread and butter for these investment banks. And it's looking pretty solid all around. So if I could give out three gold medals, I would. But it doesn't work that way.
- [07:27]
Mary Long
You Said it yourself, trading is the bread and butter for a lot of these investment banks. There's kind of a different story unfolding on the consumer side in some of these businesses. I'll highlight J.P. morgan in particular. Profit in their consumer, consumer division fell 6%. Net charge offs, which are loans that it no longer expects to be collected, grew by 9%. That's mostly in their card business. What do you make of that? Split these, these gains in investment banking revenue and these, these negative numbers in. Not negative numbers, but these, these, this slowdown on the consumer side.
- [07:59]
Matt Frankel
Yeah. So after the, the COVID pandemic started really winding down and things started really getting back to normal, which I would say, you know, 2023 was the first like completely like, I guess, normal year in a way. So we started to see loans, loan defaults kind of rise. As you know, during the pandemic, it was very easy for consumers to postpone loan payments. Things like that. No longer the case. So we saw defaults started going up. We're seeing interest rates rise, which makes it more difficult for consumers to pay their bills, especially credit cards are directly linked to the Federal Reserve's interest rate hikes. We've seen that kind of go up. But year over year looks worse than the month, the quarter over quarter, for lack of a better term. So if you Compare it with fourth quarter, 2023, that's where you mentioned correctly that JP Morgan's default rate was or net charge off rate was up by 90%. If we compare it to the third quarter, it's essentially flat. So it looks like the net charge off rates in a lot of these big banks could be stabilizing, which is definitely a very good sign. If it's steadily ticking upward like it was in the fourth quarter of last year, the first quarter of 2024, that's not a great catalyst. But if we see them starting to stabilize and they're stabilizing a little higher than pre Covid levels, but nothing that I would consider alarming and should be, well, easy to handle by the banks with all the money they're setting aside for loan losses. It's nothing to be that concerned about, but it is definitely something to watch, especially if 2025 sees some volatile economic climate.
- [09:33]
Mary Long
Let's stick on this consumer side for a moment. Jamie Dimon announced plans to bring Chase bank, the behemoth's retail arm, to Europe's largest economy being Germany. Dimon has resisted this kind of international retail expansion in the past. And this particular move is also happening at a time where You've got banks like Citigroup and HSBC ditching their decades long attempts to build out retail banks on foreign turf. Why is it so hard to bring a consumer bank to another country?
- [10:00]
Matt Frankel
Oh, well, there's a lot of reasons. It's getting easier than it was because of the rise of digital banking. It's cheaper to build out a bank than it used to be. But there's different regulations in every foreign market. There's currency fluctuations you have to deal with. There's the challenge of building a new bank from scratch. I mean, Chase is a household name in the US that's not necessarily the case everywhere where they don't already have a presence. You have to convince people who have relationships with the big German banks to ditch their banks and move to Chase. And that's not easy to do. And a lot of governments protect their domestic banks. It's a big challenge. It's easier than it used to be. If anyone could do it, well, I think it's Chase. I think it's Jamie Dimon's. There's limited growth opportunity in the US For Chase. They're the biggest bank in the world. They're the most profitable bank in history. He's under pressure to figure out ways to grow and put money to work. And, and, and I guess Europe is, Germany has about 80 million banking customers. It's the next, the next one on the horizon. But his goal, he said, is to move into all the major European countries. So I'm hoping for the best. But it's, it's an uphill battle. For sure. You're right.
- [11:11]
Mary Long
So while Jamie Dimon will keep with him for a moment, he's 68, fast approaching 69, I believe his birthday's in March. He's FAC. There was a little bit of shuffling around the C suite. Also happening this week. He's facing succession questions. Over at Morgan Stanley, we've got a relatively new CEO. Ted Pick became the head honcho at Morgan Stanley last January. He has been trying to continue his predecessor's strategy of focusing more on the company's wealth management side. The company's stated goal is to hit a trillion dollars in net assets every three years. It closed 2024 with about $252 billion in net assets. Any notes on Mr. Pick's performance a year in and perhaps advice for the year ahead or things that you'd like to see?
- [11:56]
Matt Frankel
Well, I will say that pretty much every bank earnings report that I've seen so far this week has made all the bank CEOs look like geniuses. It's really easy to do that when you're trading revenues up by. When trading revenue's up by 30 to 50% and your earnings per share are doubling year over year, it's really easy to look great. But having said that, in Morgan Stanley's case, it's not just that they've. When you said their goal is to add $1 trillion every three years, 252 billion is obviously less than one third of a trillion. But it's more than analysts thought was going to happen. The wealth management revenue was better than expected. It was up by 13% year over year. Fee income, which is really what it's all about. You can have all the assets in the world under management. If you're not generating fees, then it doesn't really matter. Fee income was 120 million more than analysts were looking for. So I always rate new CEOs on whether or not they can over deliver on expectations. And he looks like he's doing that so far.
- [12:57]
Mary Long
Earlier this week, Goldman Sachs announced the creation of a new division. It's called Capital Solutions Group. And this is a division that will focus on financing large deals, providing loans to corporate clients looking to capitalize on the private credit market. I've seen a lot more in recent weeks swirling about the private credit market. Goldman CEO David Solomon said in a statement announcing this new division that the growth of private assets is, quote, one of the most important structural trends taking place in finance. End quote. You've also got BlackRock looking to expand into this space. They're acquiring HPS. Citigroup has partnered with Apollo Global for a $25 billion private credit and direct lending program. What is the deal with private credit? Maybe, maybe before we get to what the deal with it is, maybe explain what it is because it's not something that we typically talk about when we're talking to individual investors that are interested in public markets.
- [13:51]
Matt Frankel
Yeah, we've talked about private equity a lot, which is, it's important to point out, is a totally different thing. Private equity is when you're buying, buying shares in private companies. Essentially a private equity deal is like a venture capital deal, something like that. So private credit is a non bank entity. Lending money to a business or an individual is the definition of it. Why are banks so excited about it? Banks aren't directly loaning money. They're providing capital for non banks that are loaning money. That's what private credit means. Basically the idea is that it's a lot more attractive for banks to facilitate private credit. Than to hold these loans on their balance sheet themselves. In a lot of cases, that's one of the things that got companies like Silicon Valley bank into trouble was too much credit assets. That was a big question mark for investors with their situation. It's attractive because one private credit tends to pay more than bank loans. The actual spreads depend on who you ask. But just based on one study I read, private credit pays an average of about 400 basis points higher yields than bank loans. Not hard to see why banks might like that. They're usually parts of private equity equity deals. So companies like you mentioned, BlackRock, are already big in private equity. Private credit's a logical adjacent business that they can make money off of very attractive and high rate environments. And right now we're really seeing just appetite for risk throughout the market go up. There was a big slowdown in private equity deals, private credit deals after the 2021 boom when we saw interest rates rise and all the growth stocks started plunging and things were getting. Valuation mattered to investors again. So we saw a big kind of reset and now we're seeing appetite for speculation come back into the market. So that's another big thing that's making private credit and private equity a lot more attractive. Brookfield's a company I follow and they expect their assets under management to roughly double over the next few years due to just consumer demand for private investments. And I don't see that trend changing as long as interest rates keep going down. Even if they happen slowly, if interest rates keep going down and the economy stays strong and we have a administration about to take control that has, whatever you think of it politically, the reality is they have, you know, they're more business friendly administration, they've, they're generally anti regulation, they're, they want lower corporate taxes, things like that. So it's an exciting time to have money to put to work in, in businesses. And it's not surprising that private credit's really kind of blowing up.
- [16:34]
Mary Long
Matt, there's a lot of big banks that reported yesterday today. We spent most of our conversation this morning talking about JP Morgan, Morgan Stanley, Goldman Sachs and some more broad trends that we're seeing across. But again, lots of banks reporting lots of information. Anything else that piqued your interest and that you want to flag for listeners that we haven't had the chance to talk about thus far.
- [16:55]
Matt Frankel
So far, Wells Fargo is one of the bigger surprises to me and we haven't talked about them. They're the most consumer focused out of the big four US Banks, meaning that they focus more on consumer banking, not investment banking. Their investment banking fees are going up rapidly. They grew 59% year over year. It's a relatively small part of the business, but that's the fastest growth I've seen out of all the banks that have reported so far. And Wells Fargo really kind of surprised me by saying that they expect their net interest income to go up in 2025. That was not what was the expectation going into their report. It looks really good all around. They were one of the better performing bank stocks after earnings, and there's a really good reason for it.
- [17:35]
Mary Long
That's Matt Frankel, bank guru. Thanks so much for the time and the insight and for coming on to Motley Fool Money, of course.
- [17:42]
Matt Frankel
Thanks for having me.
- [17:50]
Mary Long
Looking for a great investment? Take a page from the Peter Lynch Playbook and find a business that's boring. Up next, fool analyst Kirsten Guerra shares her passion for a stock that others might find snoozeworthy Person as the name suggests, pure storage is in the business of data storage. Specifically, it specializes in flash memory. Help me understand this. What is flash memory? How is that different than legacy hard drives and other players in the data storage space?
- [18:31]
Kirsten Guerra
I'll try to keep this as interesting as possible, but it's still data storage. So bear with me for a second. But essentially all of the legacy storage market is hard disk drives, which operate on spinning magnetic disks. And the more modern approach is solid state drives, which have no moving parts. That is way better for portable devices at least, and it's why most modern laptops use flash storage. Ours right now definitely do, but pure storage actually operates at the enterprise level and up. So like large server installations. And for that, a lot of hard disk drives are still used because they have been more cost effective, even though they're actually slower and less energy efficient. So that is hard disk drives versus solid state disks. But you asked me what flash is, and a lot of people use the term flash when what they really mean is solid state drive or ssd. I'm probably going to use these interchangeably, but pure Storage would very much like you to know that there is a difference. Solid state drives are kind of a stepping stone in a better direction than hard disk drives, but they were still almost designed backward to play nice with the existing hard disk drive landscape. They were kind of designed out of necessity, but really limited by the existing form factors, and they rely on these very limiting translation layers to do that. SSDs Solid state disks can use elements of flash, and they often do. But but Pure's approach is truly all flash from the ground up. And just so we get all of the terminology out of the way at once here. To be clear, Pure Storage brands its specific approach as what they call direct flash.
- [20:16]
Mary Long
Data storage companies aren't necessarily household names, but I'm going to venture that there are a number of other companies that play in this market. Is Pure Storage the only one that is using flash memory? Is that their moat or are there others that are using that specific kind of memory as well?
- [20:35]
Kirsten Guerra
So a lot would say that, no. Pure Storage is not the only player in Flash. But I think it does have a mode. And understanding that mode is why I got so pedantic on the solid state disks versus True Flash. When I first started looking at the company, my concern was exactly this. It was that storage is a commodity. It's interchangeable, which means it has no pricing power. Who cares what storage you put in your system, right? I do still think that that's largely true of solid state disks. But Pure Storage's Direct Flash is different. It's not a solid state disk. Unlike competitors, Pure's Direct Flash doesn't rely on this Flash translation layer. So in terms of performance to the end customer, what that actually means is that Pure's arrays, their Flash arrays are five times more energy efficient, they take up five times less space, they offer three times better data reduction, and they're just faster at data retrieval overall. And that's just in comparison to solid state disks. They're more direct competitors. But even solid state disks are already something like 14 times faster than hard disk drives. All of that is probably starting to sound like Alphabet soup by now. But basically Pure Storage's approach is kind of like the top, top tier technology right now in storage, and that is its moat. It's this technological edge and it really is the top dog in true flash storage.
- [22:01]
Mary Long
In December, Pure Storage announced, quote, an industry first Design Win, end quote. This is with an unnamed top four hyperscaler. I want to dive into what exactly a Design Win is, but before we get there, give us a quick refresher. What is a hyperscaler?
- [22:17]
Kirsten Guerra
A hyperscaler is a massive cloud service provider. So if a company doesn't maintain their own on premises cloud infrastructure, then they outsource it. They go to a hyperscaler. So those are companies like Amazon Web Services, Microsoft Azure, Google Cloud platform. Those are the big three. There's also Alibaba Cloud, that's the leading cloud hyperscaler in China. In terms of storage, what's important to know about hyperscalers is that they're by far the biggest opportunity here. Around 70% of all storage drives that are shipped go to hyperscalers. And in terms of their existing systems, about 90% of it is still hard disk drives. So if all of that is replaced over time, the hyperscalers are where the opportunity is.
- [23:00]
Mary Long
So we don't know for sure which one of the big four hyperscalers this specific partnership is with, but Pure Storage Stock soared like 20% after this announcement was made in early December during the company's earnings call. What is a Design Win? Me a layman, I'm reading this and I'm thinking Design Win. Okay, congrats. What does that actually mean and why is it such a big deal?
- [23:23]
Kirsten Guerra
Yes, congratulations is in order. I think that's fair. A Design Win just means that a company has agreed to the use of a certain component in its build out going forward. So because a typical sale would be like, okay, we've sold this enterprise, 10 storage devices, done. But a Design Win is more like we will continue to be the storage provider for this customer and all of its systems as they scale up. So it kind of implies a longer term relationship.
- [23:53]
Mary Long
Speaking of high profile partnerships, Pure Storage also has a deal with a company that everybody's talking about all the time, Nvidia. What is the nature of that deal?
- [24:05]
Kirsten Guerra
Can I first ask you a counter question, Mary? Can you name a company that does not have a deal with Nvidia, does not have a partnership with Nvidia?
- [24:14]
Mary Long
Kirsten, this is why we ask you these questions, to like bring us back down to reality to highlight the importance of things.
- [24:22]
Kirsten Guerra
Yeah. So I'll give you the details on the deal first. But the partnership is actually what they call AI ready infrastructure, or air. I maybe pronounced airy. I don't know. It's a full stack solution to simplify AI deployment, they say. Which just means that it's kind of this pre setup bundled hardware of both Nvidia's chips for compute and Pure Storage's storage blades. I wouldn't read too much into it though. I looked up Whether Pure competitors NetApp and Dell have similar partnerships with Nvidia. They do. I think the main thing to know here is that Nvidia will partner with anyone. That's kind of my biggest takeaway.
- [25:03]
Mary Long
So we'll pay more attention to the Design Win than perhaps to the Nvidia partnership.
- [25:08]
Kirsten Guerra
Definitely.
- [25:09]
Mary Long
Another aspect of Pure Storage is that it has a subscription based revenue model. So a lot is made of what they call storage as a Service. That's not SaaS, that's STAs for those that are inclined to abbreviate. But that is only about half of the company's annual recurring revenue. So how else does Pure Storage make money?
- [25:30]
Kirsten Guerra
Well, the other half or so is just the old model, right? It's the I sell you a storage box, end of deal. Come back when you need to replace that one or when you want another box. Pure Storage was the first in the industry to offer this kind of subscription instead back in 2015. But it's only in the past couple of years that it's really started to take off and it's been growing annually in the range of 22 to 24 ish percent in recent quarters. So I think in this high demand AI environment, it's especially attractive to customers that they can now upgrade whole systems without a huge upfront capital outlay and instead they can pay for it over the length of the service agreement. So I think that's what's catching on right now. And I expect that this will continue to trend more towards subscription, especially with the addition of this new hyperscaler revenue.
- [26:22]
Mary Long
CEO of Pure Storage is Charles Giancarlo, and he is a bit of a character. He wears a flat cap during a lot of his press appearances. CEO fashion sense isn't necessarily a consideration when you're thinking about investment opportunities. So flat cap aside, anything worth noting about Giancarlo's management style?
- [26:40]
Kirsten Guerra
That was a big, bold statement to say that fashion sense doesn't matter, but okay. Giancarlo has one of the most important things that I think you want to see in a leader, and that is passion for the product. I've certainly never seen anyone who has as much passion about storage technology as he does. But the other side of that passion is that sometimes he can be a bit hyperbolic. So, for example, he believes so strongly that the price point and the value proposition of True Flash is now ideal, that all enterprises will 100% have transitioned to flash within five years. He said that two years ago. I don't think we're quite on track. That's okay. I appreciate the passion. I'm sure it is also a big part of what plays into what helped him to sell that hyperscaler on Pure Storage. But when I model out Pure Storage's potential future and what it's worth, I definitely go more conservative and kind of undercut his lofty predictions.
- [27:40]
Mary Long
So you're talking about modeling out. Let's talk a bit about valuation. Right now, Pure Storage is trading at about 27 times free cash flow. You look historically at that multiple and it's been bumpy over the past few years. That 27 times free cash flow multiple is nearly double the 2023 value, roughly the same as it was in 2022, and less than half of what it was in 2021 when it was closer to 70. Can you add a bit of color to this? Why these severe ups and downs when we're trying to value this company?
- [28:11]
Kirsten Guerra
Yeah, I mean, many have said that it's expensive and. Okay, Mary, sure, If you consider 175 times earnings expensive, then I guess it's expensive. No, it definitely carries a premium valuation. One big factor I'll say on the bumpy valuation multiples that you're getting at is that transition to subscription that we talked about, as in the last couple of years, as more of that one time lump sum sales kind of revenue turns into this smoother, predictable revenue that comes in steadily over time that naturally just in the transition phase that naturally makes multiples look a lot choppier. Would expect that to smooth out to some degree as we move closer to 100% of all of their revenue being subscription or whatever their goal is. But even apart from that, truthfully, this company's value is just really hard to nail down because there is so much opportunity ahead of it. So I did a sensitivity analysis on its valuation and came out with a reasonable valuation range, anywhere from $32 to $130 per share. That was about six months ago, so it's a bit outdated, but the point still stands. That's such a wide range, it's almost unhelpful. Right. Yet all of the scenarios that I modeled to get that are, I think, very plausible, very reasonable outcomes. So it's really just tough to nail down as the existing hard disk drive landscape turns over to solid state disks and or flash. That's basically just this massive greenfield opportunity for pure storage and of course for its competitors too. But as all of these enterprises and hyperscalers upgrade into this more modern storage cycle, if pure storage can convince them of the cost benefit of all flash instead of the competitor's SSD approach, solid state disk approach, an opportunity of that scale is not one that we see often.
- [30:07]
Mary Long
Kirsten Guerra, also known as the second most passionate person in the world when it comes to pure, not pure storage, any storage. Second only to Charles Giancarlo himself. Thanks so much for the time and for the information on this company.
- [30:23]
Kirsten Guerra
Thanks so much for letting me chat storage with you.
- [30:32]
Mary Long
As always, people on the program may have interest in the stocks they talk about. And the Motley fool may have formal recommendations for or against. So don't sell or buy stocks based solely on what you hear. All personal finance content follows Motley fool editorial standards and are not approved by advertising advertisers. The Botley fool only picks products that it would personally recommend to friends like you. For Matt Frankel and Kirsten Garra, I'm Mary Long. Thanks for listening. We'll see you tomorrow.