Citigroup Inc. (C) is a leading financial services conglomerate offering financial products and services to customers around the world.
I have made it clear in no uncertain terms that I am heavily invested personally and professionally in financial stocks ranging from Citigroup to Bank of America Corporation (BAC), JPMorgan Chase & Co. (JPM), American International Group Inc (AIG) and Goldman Sachs Group Inc. (GS). I estimate that 80% of my personal liquid net worth is invested in these five companies. This is an all-or-nothing investment for me.
In 2009 and 2010, financial stocks were really cheap on all metrics, as the market assigned fire sale valuations to them and did not differentiate between commercial banks, investment banks, monoliners and insurance companies. All of them were trading at deeply depressed prices—and when the fear was at extreme levels, the valuations were the most attractive.
A couple of years have passed since then and financial stocks have recently got hammered because of worries about debt levels in Europe. I have written why I believe this to be a bogus debate, since absolutely and relatively speaking, Europe as a whole is far better financed than the U.S. or Japan.
Since some of the financials have come down significantly, in the case of Citigroup, the decline was almost 40%, I have put the purchase of financial stocks on the agenda again. Now, a lot of the charts of financial stocks look similar in comparison. From the chart of Citigroup given below, I believe shares are presently testing their bottom range at $24.3-$25.3.
When it comes to the valuation of financial stocks, I happen to look at the P/E and P/B ratios. Citigroup's P/E ratio stands at 5.5, which is ridiculously low. The P/B ratio of 0.4 reveals an equally screaming undervaluation. The shares would need to increase 150% only for the book and market value of equity to match. At this time, no premium for future residual gains will be recognized. The markets' perception of financial companies is quite negative.
Being a rigid follower of David Dreman and his outstanding book "Contrarian investment strategies," I am reaffirmed to add to my position in Citigroup.
I would suggest that a company with a profit margin of 14% and a historical return on equity in the high single digits could still achieve a P/E multiple of 15 in the long term—based on underlying, recurring earnings. Since Citigroup trades at only around 5x earnings now, the shares could triple in value over the next cycle, which, I believe, will take about 3-5 years to unfold.
If we suggest that the market fairly valued Citigroup in 2004-2005, the bull phase in the last cycle without the influence of the bear market in 2003 and the mortgage hype in 2006-2007, the intrinsic P/B would stand at above two, sometimes well above two. This is not an assumption. This chart should indicate to readers that the historical book value of Citigroup has been consistently above two (and in effect continuing well into 2007). Furthermore, the chart shows how far current P/B values deviate from historical P/B ratios on a sector-wide basis.
As Citigroup trades now at only 0.4x book value, compared with over 2x historical book value, the stock has a fair chance of becoming a multi-bagger once the US enters a new boom period. I find the valuation discrepancy exhilarating and have made it my top priority to increase my clients' and my own Citigroup positions. As history repeats itself, I do believe that Citigroup has tremendous potential to catch up in valuation based on historical benchmarks and could be the multi-bagger of the decade.