In a market that's repeatedly being called overvalued, it's becoming increasingly difficult to find stocks with financial statements able to justify their prices. This is especially true of well-known companies like Bank of America (BAC) and Citigroup (C). But, Bank of America and Citigroup are two big banks with big margins of safety. Here's why they're undervalued:
- Their relative values compared to their competitors; namely, JP Morgan Chase (JPM), Wells Fargo Corporation (WFC) and US Bank (USB)
- Their prices and market caps relative to their historical values
The best way to analyze a stock, in my opinion, is not by looking at its share value, but instead at its market cap, because the value of a company is not determined only by its stock price but also by the number of shares outstanding. In this case, the information is quite informative:
Although Bank of America and Citigroup are larger than Wells Fargo in terms of assets, they're trailing behind significantly in terms of market cap. US Bank, which is actually the fifth largest bank in the United States by assets, is catching up to Bank of America and Citigroup in terms of market cap, which are respectively the 2nd and 3rd largest banks in the US. The discrepancy in market caps relative to assets would make sense if Bank of America and Citigroup were having trouble posting positive earnings, or if they were overwhelmed with debt, but rather, the following table of key ratios shows that neither of those circumstances are true:
|Ticker/Ratio||Price to Tangible Book ratio||Price to Free Cash Flows ratio||Price to Earnings ratio|
In the key ratio table lower numbers are better, in terms of getting a bargain. Here the imbalance between the banks' values is even more pronounced. Based on these numbers only, Citibank is the most undervalued, and arguably either JP Morgan or Bank of America comes next. I personally think that Bank of America is by far the second most undervalued of the five, because of its tangible book value per share (i.e., how much the company's physical assets are worth on their books, relative to their market cap). Although the price to free cash flow ratio is an important indicator, it can change a lot faster than two trillion dollars in assets. Especially since Bank of America has become profitable again, and hence their assets shouldn't be disappearing anytime soon.
To focus on the previous values of the companies: Bank of America is significantly down from its recent historical high of almost $54 per share, but also significantly up from its annual low of $4.92. Part of the reason that Bank of America is so far below its previous price of $54 per share is that the share volume has expanded. Hence, using market cap is a more fair assessment. With regards to market cap, Bank of America is still seemingly undervalued, as its recent market cap peak was in 2008, at just over $200 billion.
Similarly with Citigroup, its historical high appears to be at $583 per share, which is far above its present price. Also, it has recovered from its annual low of $21.40. With regards to market cap, we see that Citigroup must have issued a large amount of shares as well, but still that its market cap is well below its recent historical value of $246 bilion.
In response to the above considerations, some of my more pessimistic friends would assert that the Efficient Market Hypothesis implies that there is something we don't know (or rather, that some investors do know) which is factoring into the share price. Of course, although there could be something else critical that's contributing to these banks' being undervalued, there isn't necessarily. In order to further dispel the Efficient Market Hypothesis as a principle, consider: all of the people that profited off of the United States housing bubble, the existence of bubbles, Warren Buffett, who has managed to profit extremely well off of what he's seen as undervalued stocks.
To be fair, some investors are likely concerned over Bank of America's recent and continued shedding of assets, and that Citigroup is one of the 7 banks being hit with libor subpoenas. With regards to Bank of America, investors shouldn't be too worried, as Bank of America says that its purpose is to focus on furthering its long-term stable "Global Banking and Markets Business" and that in this case the effects will have an immaterial impact on their balance sheet. In Citibank's defense, JP Morgan Chase is also on the list of banks being served with subpoenas, and its shareholders are evidently still confident.
In closing, Bank of America and Citigroup are two of the biggest banks in America, and they're considerably undervalued: relative to their competitors and to their historical lows. There may be some information which is factoring into the share price that is not conveyed in the companies' financial statements, but if it doesn't materialize then it shouldn't effect their stock prices permanently. If these two stocks stay below their tangible book values for long it will be because of extraordinary circumstances, assuming they can keep their earnings positive.
1 Market cap data is from Google Finance
2 Data for the Key Ratio table is from Forbes' website