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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%-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 bolstering bank earnings.

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, stock prices are tied to future expectations, but these results prove that we're already seeing these companies post big gains. How does that happen? You mentioned 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 bakers are attributing part of their success to what they're anticipating will come into future, how are we already seeing such obvious successes in their current earnings?

Matt Frankel: 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 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. When you're talking about doing corporate tax cuts, which the incoming administration has mentioned, banks could be a big beneficiary of that. That's just one example, but there's also the deregulation makes an easier M&A environment, which also would add even more fuel to the investment banking world as more companies are able to get M&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 deal to go through under the new administration. There's a lot of future catalysts, but the investment banking side is really what we've seen catapult earnings this quarter.

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 it's core CPI. This is a number that excludes more volatile costs like food and energy that slowed for the first time in months. 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?

Matt Frankel: 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 one off, just some good inflation data and a C of bad. Then the CPI data came out and confirmed that in December, inflation really was less than expected. The short answer is that faster rate 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 of years as interest rates have risen and if they cut more aggressively than expected, it can 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.

Mary Long: I'm 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 $3.5 billion. Morgan Stanley's 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 is fierce competition between these three banks. As a financial investor, as our go to guy when we want to talk banks, how much money do you pay to which of these three is in gold, silver, bronze on the podium? How do you actually compare their successes side by side?

Matt Frankel: This is definitely a case of a rising tide [inaudible] 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. A volatile market, whether it's going up, going down, volatility is good for trading revenue in these investment banks. It's really a rising tide with Soulship 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 JP Morgan. They beat on the fixed income side, but not the equity side. 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. If I could give out three gold medals, I would, but it doesn't work that way.[laughs]

Mary Long: You said it yourself, trading is the bread and butter for a lot of these investment banks. There's a different story unfolding on the consumer side in some of these businesses. I'll highlight JP Morgan in particular. Profit in their 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 gains in investment banking revenue and this slowdown on the consumer side.

Matt Frankel: After the COVID pandemic started really winding down and things started really getting back to normal, which I would say, 2023 was the first completely, I guess, normal year in a way. We started to see loan defaults rise as 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 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 go up, but year over year looks worse than the quarter over quarter for lack of a better term. If you compare it with fourth quarter of 2023, that's where you mentioned correctly that JP Morgan's 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 bags could be stabilizing, which is definitely a very good sign, if it's steadily ticking upward like it was in 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 alarm and should be 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.

Mary Long: Let's stick on this consumer side for a moment. Jamie Dimon announced plans to bring Chase Bank, the behemoth retail arm to Europe's largest economy, being Germany. Dimon has resisted this 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?

Matt Frankel: 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. 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. We know that in case 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. 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. I guess Germany has about 80 million banking customers. It's 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 an uphill battle, for sure. You're right.

Mary Long: While Jamie Dimon, we'll keep with him for a moment. He's 68, fast approaching 69, I believe his birthday's in March. He's facing some succession questions. 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. Has been trying to continue his predecessor 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?

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 trading revenues up by 30-50% 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, 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. 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.

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 "one of the most important structural trends taking place in finance." 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? 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.

Matt Frankel: We've talked about private equity a lot, it's important to point out as a totally different thing. Private equity is when you're buying shares in private companies, essentially. 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 deals. Companies like you mentioned BlackRock are already big in private equity, private credit is a logical adjacent business that they can make money off of very attractive and high rate environments.

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. We saw a big reset, and now we're seeing appetite for speculation come back into the market. That's another big thing that's making private credit, and private equity a lot more attractive. Brookfield is 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. 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 administration about to take control that has. Whatever you think of it politically, the reality is they're more business friendly administration. They're generally anti-regulation. They want lower corporate taxes, things like that. It's an exciting time to have money to put to work in businesses, and it's not surprising that private credit is really blowing up.

Mary Long: Matt, there's a lot of big banks that reported yesterday. 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 the industry. But again, lots of banks reporting, lots of information. Anything else that pictured your interest, and that you want to flag for listeners that we haven't had the chance to talk about thus far.

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. Wells Fargo really 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.

Mary Long: That's Matt Frankel, bank guru. Thanks so much for the time and the insight, and for coming onto Motley Fool Money.

Matt Frankel: Of course, thanks for having me.

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 snooze-worthy. Kirsten, 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?

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. The more modern approach is solid stage 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. 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. That is hard disk drives versus solid state disks. But you asked me what flash is. 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. ut Pure Storage would very much like you to know that there is a difference. Solid state drives are 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 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 Pure's approach is truly all-flash from the ground up. 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.

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 mode, or are there others that are using that specific memory as well?

Kirsten Guerra: A lot would say that no. Pure Storage is not the only player in flash, but I think it does have a mode. 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. 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. 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, their 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 like the top tier technology right now in storage, and that is its mode. It's this technological edge, and it really is the top dog and true flash storage.

Mary Long: In December, Pure Storage announced, "An industry first design win." 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?

Kirsten Guerra: A hyperscaler is a massive cloud service provider. If a company doesn't maintain their on-premises Cloud infrastructure, then they outsource it. They go to a hyperscaler. 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. In terms of their existing systems, about 90% of it is still hard disk drives. If all of that is replaced over time, the hyperscalers are where the opportunity is.

Mary Long: We don't know for sure which one of the big four hyperscalers, this specific partnership is with. But Pure Storage stocks soared 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 time thinking, design win, congrats. What does that actually mean, and why is it such a big deal?

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 buildout going forward. Because a typical sale would be like, 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. It implies a longer term relationship.

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?

Kirsten Guerra: Can I first ask you a counter question, Mary? Can you name a company that does not have a deal with NVIDIA [laughs] Does not have a partnership with NVIDIA?

Mary Long: Kirsten, this is why we ask you these questions to bring us back down to reality, to highlight the importance of things.

Kirsten Guerra: I'll give you the details on the deal first. But the partnership is actually what they call AI-ready infrastructure, or AIRI maybe pronounced AIRI. I don't know. It's a full stack solution to simplify AI deployment, they say, which just means that it's 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 my biggest takeaway.

Mary Long: We'll pay more attention to the design win than perhaps to the NVIDIA partnership.

Kirsten Guerra: Definitely.

Mary Long: Another aspect of Pure Storage is that it has a subscription-based revenue model. A lot is made of what they call storage as a service. That's not SaaS. That's SSDs for those that are inclined to abbreviate. But that is only about half of the company's annual recurring revenue. How else does Pure Storage make money?

Kirsten Guerra: Well, the other half or so is just the old model. It's the, I sell 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 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 22-24-ish percent in recent quarters. 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. I think that's what's catching on right now, and I expect that this will continue to trend more toward subscription, especially with the addition of this new hyperscaler revenue.

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. Flat cap aside, anything worth noting about Giancarlo's management style.

Kirsten Guerra: That was a big bold statement to say that fashion sense doesn't matter. But 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. 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 OK. 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 undercut his lofty predictions.

Mary Long: 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?

Kirsten Guerra: Many have said that it's expensive. 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 revenue turns into this smoother predictable revenue that comes in steadily over time, just in the transition phase, that naturally makes multiples look a lot choppier. I 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. I did a sensitivity analysis on its valuation, and came out with a reasonable valuation range anywhere from $32-$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, yet all of the scenarios that I modeled to get that are, I think, very plausible, very reasonable outcomes.

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 competitors SSD approach, solid state disk approach, and opportunity of that scale is not one that we see often.

Mary Long: Kirsten Guerra, also known as the second most passionate person in the world when it comes to any storage. [laughs] Second only to Charles Giancarlo himself. Thanks so much for the time, and for the information on this company.

Kirsten Guerra: Thanks so much for letting me chat Storage with you.

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 advertisers. The Motley Fool only picks products that it would personally recommend to friends like you. For Matt Frankel and Kirsten Guerra, I'm Mary Long. Thanks for listening. We'll see you tomorrow.

JPMorgan Chase is an advertising partner of Motley Fool Money. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Citigroup is an advertising partner of Motley Fool Money. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Wells Fargo is an advertising partner of Motley Fool Money. Discover Financial Services is an advertising partner of Motley Fool Money. Kirsten Guerra has positions in Alphabet, Microsoft, and Pure Storage. Mary Long has no position in any of the stocks mentioned. Matt Frankel has positions in Amazon and Capital One Financial. The Motley Fool has positions in and recommends Alphabet, Amazon, Goldman Sachs Group, JPMorgan Chase, Microsoft, NetApp, Nvidia, and Pure Storage. The Motley Fool recommends Discover Financial Services and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.

What the Big Banks Are Up To was originally published by The Motley Fool