By Jeff Bailey
It's hard to argue with the editors at Barron's who laid out their top 10 stock picks for 2014 over the weekend. After all, the 2013 list is beating the S&P 500 by nearly ten percentage points and included such smart calls as Blackrock (BLK), Viacom (VIAB) and Western Digital (WDC).
BLK data by YCharts
Well done, Barron's.
With the 2014 picks - which include bold choices US Airways (LCC), Barrick Gold (ABX) and Deere (DE) - we have just one nit: Citigroup (C). Yes, yes, yes - it remains a turnaround and is so beaten down it will very likely rally further in 2014. And it may indeed outclass many other bank stocks in doing so.
But is this a company you should own long term? One of Barron's main reasons for recommending this stock, other than its cheapness, could easily be an argument for not owning it. Citigroup, the publication notes, "has the best international franchise among major banks." It's in 100 foreign countries, we're told, and gets nearly 60% of revenue from outside North America.
In theory, well, super. Faster-growing economies and all that. Citigroup beat other U.S. banks into these markets.
In practice? Foreign markets are unkind to banks (and to most companies; ask Wal-Mart (WMT), where the international business grows but its margins disappoint.). They tend to overpay (either by way of price or by taking on excessive risk) for acquisitions overseas. Even with locals hired on the ground, a U.S. bank will have a harder time, we would argue, avoiding crummy customers than would local lenders.
Worst of all: it's complex and banks ought to strive for simplicity, we believe. The No. 1 competitive advantage in banking is not screwing up (ask Lehman Bros. or WaMu) - or, more precisely, avoiding the costly errors your competitors are likely to make. Keeping things simple can help a bank do that.
That thinking has led us to write favorably about the shares of Wells Fargo (WFC) and U.S. Bancorp (USB) on a number of occasions. These two run an almost entirely-domestic operation, skewing toward consumers and small business and eschewing proprietary trading and the other manly pursuits of Wall Street. They have management teams that love to accomplish something utterly boring and at the same time wonderful: incremental improvement. Raising productivity here. Persuading existing customers to do a little more business there. Just a general and unending tightening of the screws. It's grubby, yes. But over time, compounded, it has made them both top-performing companies (not just banks) and landed their shares in the portfolio of Berkshire Hathaway (BRK.A) (BRK.B), where Warren Buffett seems to prefer slow and steady to flashy and risky.
Year-to-date, Citigroup has slightly out-performed our dullards, as seen in a stock chart.
C data by YCharts
But guess what? Based on forward forward PE ratio, Citi isn't really any cheaper than Wells Fargo, which has been unloved of late because of its huge market share in the mortgage-making industry.
C PE Ratio (Forward) data by YCharts
Current rate of return - based on return on assets - suggests Citigroup has more upside that Wells Fargo and U.S. Bancorp, and that's hard to argue with. But look at the full ten years.
Citigroup's return on assets before the financial crisis was pretty decent, but overstated, one would argue, given the losses it was forced to recognize once the tapioca hit the fan. It hasn't in recent memory been a consistent top earner, and approaching the heights of 2% return-on-assets and then sustaining it requires a culture of excellence, risk avoidance and continuous improvement. You'll find those characteristics present at Wells Fargo and U.S. Bancorp, we believe, but far less so at Citigroup, JPMorgan (JPM) and Bank of America (BAC).
So, Citigroup may be a brilliant trade, but it doesn't seem like a bank that lets its owners sleep well at night.