By Matt Doiron
Even after a 39% rise in the last year as investors have become less worried about European and global macroeconomic issues, Citigroup Inc. (C) trades at a P/B ratio of just less than 0.7. This discount to book value is often offered as the core of a case for why Citi is a value stock; in theory, many retail and mutual fund type investors are still avoiding it and other major banks because of poor sentiment due to the financial crisis, and in time the market cap should converge closer to book value. The bank was one of the ten most popular stocks among hedge funds in the third quarter of 2012 (see the full top ten list) as hedge funds and other notable investors liked the value opportunity.
Citi has not been doing well at converting these assets into earnings, though analyst expectations are for strong improvement in that area. The current stock price places it at 17 times trailing earnings, and in the most recent quarter net income was up 25% from the fourth quarter of 2011 (with most of this gain coming from improved margins- revenues increased only 5%). Wall Street consensus is for $4.60 in earnings per share in 2013, which equates to a current-year P/E multiple of 9. The five-year PEG ratio is 0.8, indicating that continued earnings estimates show growth for the next several years. Of course we don't put too much weight on sell-side estimates, but the combination of a discount to book value and a general expectation that the stock is undervalued relative to future performance suggests that Citi could be worth further consideration.
We've already mentioned the breadth of hedge fund interest in Citigroup Inc. Billionaire David Tepper's Appaloosa Management increased the size of its position in Citigroup by 10% in the third quarter of 2012, and closed September with over 10 million shares in its portfolio. This made Citi one of the fund's largest holdings (find more of Tepper's favorite stocks). Moore Global, managed by fellow billionaire Louis Bacon, initiated a position of 5.3 million shares during the quarter (check out Bacon's stock picks).
Bank of America Corp (BAC) and JPMorgan Chase & Co. (JPM) also have market caps lower than the book values of their equity, though the gap has all but disappeared in JPMorgan Chase's case (Bank of America's P/B ratio is 0.6, giving it an even larger discount to book than Citi). Forward P/Es for the 2014 fiscal year are in the 8-9 range, which is in line with where Citi is valued. However, the recent business performance at these three banks has been very disparate. We've already mentioned the significant improvements at Citigroup; JPMorgan Chase has been doing even better, with revenue up almost 20% in its most recent quarter compared to the same period in the previous year and earnings up over 50%; Bank of America experienced double-digit percentage declines on both top and bottom lines. As a result JPMorgan Chase might be a better buy than Citi, while Bank of America looks like it should be avoided.
We can also compare Citigroup to Wells Fargo & Company (WFC) and to HSBC Holdings plc (HBC). These banks are also in the 8-9 range in terms of forward P/Es, reflecting that while they actually trade at significant premiums to book value the consensus is that they will continue to do a better job of generating income from their assets than the banks we've previously discussed. HSBC's business has been down, but Wells Fargo has been recording gains in both revenue and net income and despite its high valuation in book terms we think that it is worth a look.
We continue to see the two best picks among megabanks as JPMorgan Chase and Wells Fargo. These two banks seem to have a narrow edge over Citigroup Inc. in that we consider them to have lower downsides, but their value potential in terms of where they trade in relation to forward earnings is about even.
Disclosure: I am long C.