Those who have been invested in Citigroup (C) for any period longer than 2 years have been decimated by the crushing decrease in share price. The purpose of this article is to present the case that the brutal drop and suppression in share price is ending and that the stock price may be in the process of bottoming. Additionally, I present the fair valuation of Citigroup at over 700% the current share price due to the price to book valuation method as shown later in the article. I conclude with a technical framework detailing when investors should participate in the rise of this banking giant.
Throughout the past 6 years, Citigroup has dropped over 95%. In the below chart, investors can see what $1 invested at the beginning of 2007 would be worth today. As a comparison, the Vanguard Financial ETF (VFH) has been included.
Despite this significant underperformance, I believe that fundamentally, Citigroup has formed the basis for upward growth. The first factor I have relied on in this analysis is profit margin. Profit margin is essentially the net profit of the organization as a percentage of revenues. As a firm becomes more efficient and trims their expenses, profit margin increases.
The past 10 years of historic profit margin can be seen for Citigroup in the above chart. Investors' eyes are quickly drawn to the blemish in the middle of the chart. During time period of late 2007 until early 2010, the profit margin (and even the viability) of Citigroup was strongly questioned. It was during this period of uncertainty that the stock price dropped a staggering 90%. In early 2010, Citigroup recovered its profit margins and has been experiencing positive margins since the end of the financial crisis. This data by itself does not warrant any particular action; however it does show a clear resumption of profitable operations. Once a firm has achieved profitable operations, the investor must then question what the firm is doing with its achieved profits.
In order to determine how a firm is using its gained profits, we can examine a number called retained earnings. Retained earnings are the portion of earnings that a firm invests back into the corporation.
In the above chart, the historic retained earnings of Citigroup can be seen. As we have previously discussed, Citigroup reached its apex in early 2007, and this apex can clearly be seen in the above data. From the years of 2007 through 2009, Citigroup was using any extra revenues to survive, and this fight for survival led to a steady decrease in retained earnings. Something very fascinating occurred in early 2010. Beginning in 2010, Citigroup gradually and consistently began to reinvest earnings directly into the core business of the firm.
Through retained earnings, analysts can gain insight into how the firm is using its earnings. Rather than increasing retained earnings, companies could pay a dividend. Any investor who has participated in Citigroup stock for several years has witnessed an incredible decrease in dividends over the past 10 years.
While this decrease in dividend is misfortunate for many investors, it is important to note that any cash saved can be reinvested into the company. For a company which was struggling to even stay afloat during the financial crisis, Citigroup made an excellent decision to slash the dividend. My major criticism is that they delayed until 2009 to cut its dividend down to mere pennies. Any earnings which are saved can be reinvested into the company for future growth.
Future growth at the very basic level is measured by assets. The definition of an asset is something which can provide a current or future economic benefit. This said, it is important that we analysts examine this very basic definition to see if Citigroup is in a position to reap future economic benefit.
The book value of Citigroup can be seen in the above chart. Book value is the value of all of the assets on the balance sheet of the firm. The above chart is truly remarkable in that despite the financial crisis, Citigroup immediately rebounded and resumed a very steady increase in assets. To say it another way, Citigroup has rebounded to new levels of potential economic benefit.
Citigroup is a bank and its loans (assets) are what it uses to generate revenue. As its assets increase, its ability to generate future profits increases. At the most fundamental level, Citigroup has been reinvesting its earnings into itself to increase its assets, so that they can resume future economic growth. With such an easy to see picture of reinvestment at hand, why is the market missing it?
The market seems to be concerned with the immediate future of fixed income and interest rates. Since Citigroup as a bank directly profits from interest rates, it seems that this is the fundamental issue which is currently affecting the market's perception of the organization. With interest rates at decade lows, investors are concerned that Citigroup will not be able to generate additional profits on its assets which directly accrue interest.
What convinces me that the market perception is wrong and that Citigroup will prevail are some basic fundamental analysis techniques. The main technique I examine is the price to book ratio. This ratio is a way to compare the stock price to the book value of assets. The price to book ratio is very handy in that it allows us to take the previous chart we examined and compare it to stock price to gain an understanding of what investors are paying to own the assets in the company.
As can be seen in the above chart, each dollar invested in the company allows an investor to own a greater share of assets as time progresses. In 2006, the price to book ratio was 2.3, and today it is .42. This means that investors value the assets at 20% of what they once were. The company has actually increased its assets by 30% during this same time period, yet people are not willing to pay but a small value for them.
What is truly amazing about the current price to book level is that it allows us to back out a fair price for the stock. In the year 2006, in the above chart, it can be seen that the price to book ratio was around 2. This essentially meant that investors were paying $2 per share of assets to own the company if it were it to go bankrupt and convert all of its assets directly into cash. After the financial crisis, this ratio has oscillated at around .50. Something to note is that during this period assets have already overcome the pre-crisis highs and are steadily making new highs, as seen in the Book Value Chart. This means that despite the company growing its ability to generate revenues, the market has not been willing to pay more to own the assets of the company.
It is my belief that the market is in the process of revaluing Citigroup at pre-crisis highs. As they have steadily grown their assets, they have been consistently growing their ability to increase their earnings. As their earnings have been increasing, they have been steadily reinvesting into future corporate growth. With the fundamental picture firmly established, Citigroup is in place to be priced fairly, according to its pre-crisis highs. This is where it gets interesting. That fair price would be such that their price to book ratio is at or around 2.3. By using the price-to-book formula, we can back out what a fair price for this ratio would be. In the table below, this valuation process can be seen. If Citigroup were to even regain its 2006 valuation on a per asset basis, the associated stock price would be $225 per share. This represents a 729% increase from today's stock price! This share price seems dramatic; however, it is fundamentally supported in that not only has Citigroup surpassed their book value of 2006, but they have steadily invested their income into future economic expansion.
The market has chosen to overlook the core business of Citigroup and how they have been steadily expanding their earnings capability, and instead they have focused on the low interest rates and the previous damage done to the company during the crisis. Through using the price to book ratio, we are able to determine that when the market decides to fairly value the assets of the company again, the share price should be $225 to make this form of valuation equal to pre-crisis levels.
The key risk here is that the market could continue to ignore the fact the company is valued at a sliver of what it should be. This risk is addressed and can be mitigated through my below technical synopsis.
Despite such bullish analysis, investors should be pragmatic in their investments. I have found that by using technical analysis to time my entries and exits, I am able to best execute my fundamental analysis. Looking at the below chart, I believe that investors should consider the current floor to be around $23 per share. If the stock falls below this point, I view this analysis as poorly timed. In the meanwhile, it seems as though stock price is forming a temporary floor around $25 per share and price very may well progress upwards from here.