Bank stocks were getting clobbered on Friday and Monday as investors absorbed the fallout from the Brexit referendum that sent ripple effects around the world. Major stock market indices in Europe were in free-fall after Brits voted to leave the European Union in last week's referendum, and it created significant uncertainty in the financial markets.
U.S. stock markets fell hard and fast, too, but have rebounded a bit on Tuesday when investors started to buy risk assets again. Currency markets also reflect the impact of the once-in-a-generation referendum, with the pound slumping to a more-than-31-year low against the U.S. Dollar earlier this week. The market meltdown reflected investors' emotional meltdown. British banks in particular fell off a cliff, which was to be expected, but the fate of U.S. banks depends for the most part on the U.S. economy, and not on the British one.
Compelling Reward-To-Risk Ratios
This, however, could turn out to be a big mistake. For one thing, it is more than probable in my opinion that investors have overreacted to the Brexit vote. Second, Citigroup is now so underpriced that the reward-to-risk ratio is tilted very much into investors' favor.
The case for buying Citigroup in light of the market crash is chiefly driven by valuation considerations.
No investor really knows at this point what the future holds for Britain's banking hub after the referendum. Therefore, there is a LOT of speculation and worst-scenario pricing included in current securities prices. As a result, U.S. banks have simply become TOO cheap.
Citigroup's shares, for instance, are changing hands for 57 cents on the dollar, or ~7.4x next year's estimated earnings. The steep discount to accounting book value, or ABV, reflects deep investor concerns over Britain's economic future. While there are indeed legitimate concerns over Britain's economic growth trajectory over the short haul, the discount to Citigroup's accounting book value has just become too large in my opinion. The discount is approaching 50 percent (!), reflecting expectations of a severe global recession and growing earnings risk.
Citigroup Is A Growing Bank
I posted this graph in my last article about Citigroup, 'Citigroup: Be Patient'.
It shows that Citigroup's book value has healthily grown (about 11 percent) over the last two years, giving investors little reason to price heavy book losses into Citigroup's shares.
Citigroup looks like a good deal at the current price point since the bank largely relies on the U.S. for its profits and since its business has grown at quite a good clip, too.
Banks were kicked to the curb over fears that the Brexit will be an economic catastrophe. But investors will calm down over time and regain their composure. All considered, the emotionally-fueled market meltdown has made already cheap stocks like Citigroup a whole lot cheaper. After the recent market swoon, Citigroup can be gobbled up for a ~43 percent discount to accounting book value, a steep margin of safety indeed. Citigroup looks very appealing from a valuation and reward-to-risk ratio perspective in my opinion. Buy for capital appreciation.
Disclosure: I am/we are long BAC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.