Now that we have unlimited quantitative easing, aka QE infinity, careful thought must be given to choosing bank stocks. Sure the "lift of all boats" action of quantitative easing should help bank stocks across the board. However, the goal of easing is to lower long term rates, which could hurt bank stocks. Hurt might even be too strong of a word. It might just ding them. So when it comes to picking a specific stock it is prudent to apply rigorous fundamental analysis and choose the stocks with the most to gain and the least likely to be toppled after temporary positive catalysts fizzle.
This will be a three part series. I will look at Bank of America (BAC) vs. Citigroup (C) and then look at Wells Fargo (WFC) and JPMorgan Chase (JPM). Two parts will be here on Seeking Alpha and the last will be on my own page since I will have little analysis to add, and both winners from each article will be great long positions. The difference will be the kind of investor they are best for by looking at the risk-reward.
Bank of America - The Numbers
Bank of America is probably my favorite bank stock. It also ranks in the top 10 for me. I find it is so heavily undervalued that it presents a fantastic opportunity. I also think Bank of America is on a good path. Therefore, it needs to get fairly valued and will rise as business improves. So first we should turn to some key stats.
First, the price-to-book ratio for Bank of America is 0.4738 with the book value per share being 20.16. That is a good amount from the current $9.55 that Bank of America is trading at. Not to suggest that Bank of America need trade at a P/B ratio of 1 or higher. A P/B ratio of about 1.8 to 2.0 was common before the credit crisis. I am not greedy. I would be looking for a ratio of 0.8. That would still provide a good return.
Next it is time to look at net income ttm. I like the trailing measure because it incorporates the trend into the value and evens out wild swings. Bank of America sports a $9.911B net income ttm, but what I like is that this number just flipped to positive. I would look for it to stay that way. Bank of America has not moved in forever. I have been watching it languish below $10. Only recently has it started to show fantastic signs closing at $9.55 on September 14, 2012. It is still not too late to get started in Bank of America. I will probably jump in shortly.
Bank of America's profit margin could do with some improvement. It is below the other banks' profit margins lying at 7.94%. In fact it is the lowest of the group. If it puts some cost controls in place or cut costs whilst increasing revenues then that amount should go up. I think going with the laggard could be the best choice. If Bank of America manages to squeeze out more profit from its revenues then it should appreciate as a result even if revenues stay flat. Wells Fargo with its 19.48% profit margin probably needs to increase revenue to increase profits. Bank of America has some wiggle room. Considering how undervalued I consider Bank of America to be, having the ability to fatten its margins in addition to increasing revenues makes me like it more.
The logical next consideration would be revenue growth. The sad part is that no clear trend has emerged with Bank of America. While its 38.73% is a new development I remain optimistic. Last quarter showed negative revenue growth. I will be looking for continued positive revenue growth, even if it cools off from 38%. That is where the profit margin comes in. It can make less go farther, because it has not maxed out its margin.
I do not want to over-analyze this. There are just a few more factors you can glance at, but I do not think a comprehensive explanation is necessary. For example, I did net income so I will ignore earnings per share in my analysis. Do take a look at that metric, but I will leave it and a few other important metrics off. They do not provide any more input from what I have covered.
The final factors to glance at are cash, long term debt, and free cash flow. All of these look good. Bank of America has ample cash. I know it is a gross oversimplification, but I normally look for cash to be greater than long term debt. It might just be for my own peace of mind, but I regard it as a good thing. Bank of America has over $250B more in cash than long term debt. Free cash flow at $18.36B is good too. I just glance at that number to make sure that net income is not skewing actual cash earned. Another oversimplification is that cash is fantastic.
In all my discussion of Bank of America being undervalued, I think it is only fair and necessary to point out that its price to earnings ratio is in line with its peers, sitting at 9.948. The market does not need to catch up to Bank of America's cash producing abilities. Bank of America is undervalued because it has a ton of assets that the market is undervaluing. That is not surprising, because banks are sitting on some very risky assets like mortgages. I think the fear priced into Bank of America is overblown, however it is a concern. It also means that Bank of America is not putting its assets to good use. It has a price to book lower than all its peers but a price to earnings in line with them. Even in absolute terms its net income is not out of line with its peers. If it can increase its margins that would lead to increases in price to maintain its P/E or it will lower the P/E creating more of an opportunity.
Citigroup - The Numbers
I like Citigroup a lot less. I cannot always place my finger on why I do not like it. I think it is just I prefer Bank of America, though every option should be thoroughly analyzed before making a decision. Citigroup is also considered to be undervalued. The stock has recovered from some severe issues from 2008. No point in rehashing history. Citigroup is one of the banks that took one to the chest and managed to bounce back. I will go over the numbers in the same order as Bank of America.
First, the price-to-book ratio for Citigroup is 0.5498. It is not so above Bank of America to automatically make it lose the undervalued round as I am calling it. Plenty of upside if you consider the book value per share being $63.27. Citigroup is currently at $34.79. I would still be looking for 0.80 on the P/B ratio. That might be a bit conservative and I might be inappropriately discounting Citigroup. Bank of America probably has a far greater number of questionable loans though there is no way to be sure, while Citigroup suffered in the last five years and it might have written off more bad loans already. If you want to play it riskier then maybe look for 0.90 P/B on Citigroup.
The net income ttm for Citigroup is good at $10.60B, but it has been at these levels since around 2011. I am not knocking it, because that is a fantastic result. However, the market has had one year to price in Citigroup's fantastic net income. Bank of America just went positive; obviously Bank of America is risky compared to Citigroup. Citigroup has been consistent. However, I think Wells Fargo and JPMorgan Chase are the bank stocks for the more conservative-minded. In the battle between Citigroup and Bank of America, I would have to go with Bank of America. I may be foolish to rely on psychology, but I think the market has had enough time to evaluate Citigroup on its consistency. However, Bank of America still needs to prove its consistency, and I think it can rise a few points if it does succeed.
Citigroup also could use a boost in profit margins that are at 12.20%, but they are higher than Bank of America's. The same analysis as above applies here. Citigroup again wins out on consistency; the range is between 4% and 14%, roughly. Bank of America might just be starting on increasing its margins, but notice I said might. The one downside to Citigroup's consistency is that it has not been going up. The chart I linked is a bit deceiving. Margins were so low a few years ago that even moves of 10% don't register like they should because the scale is off. Bank of America lacks consistency, and a real upward trajectory. A few more quarters are needed before a conclusion can be made. I still like Bank of America better, because signs are not negative but sentiment is negative. Also, I think Citigroup is far more fairly valued, and that is a bad thing.
Turning to revenue growth we find Citigroup has -11%. That is not very heartening. Not sure if it is indicative of a bigger problem - it has been consistently negative. Bank of America's has been positive, but only for the most recent quarter. I would lean conservative and say that Bank of America's monster revenue growth was an aberration. Next quarter is critical, if Bank of America stays positive for revenue growth then that would be a positive sign even for a conservative mindset. I would probably not wait till earnings to take a position though. I tend to lean more on the riskier side. Always do what is right for your stomach.
Cash and long term debt for Citigroup are better than Bank of America. Citigroup has about $500B more in cash than long term debt. You can take a look at the specifics on your own. Free cash flow is negative. This might be bad, or it could mean Citigroup is heavily reinvesting into itself. It remains to be seen if this will pay off. Citigroup has cash to spare. I know I said cash is fantastic, but sometimes reinvesting in the business is a good thing. In the past free cash flow has been positive. I just hope it is putting its funds to good use. The price to earnings ratio is in line with the rest of the banks so the same analysis as Bank of America applies here.
I know I talked a lot about Bank of America in the section about Citigroup, but if I did not I would have to add a whole section comparing the numbers side by side. That would just involve repeating myself and you would all hate me. Also, I would normally talk about product and technology developments at this point, but I am not looking at the new debit card technology or anything. Banks do not really have new products, and when banks get fancy with their paper products the world might suffer. Maybe I am jaded in my old age, ignore my cynicism.
Conclusion and Trade Ideas
I am sure it is no surprise that I like Bank of America best. This round goes to it. I believe that Bank of America has more space to move. This does not make Citigroup an investment to be flushed if you own it or just like it for whatever reason. I just think that Bank of America will be the big mover soon. I do not want to lock myself into a time frame but six months to a year should see a good increase.
In addition to considering a long position I might go with some $12.50 January 2013 calls. I wrote about them before here. They used to be cheaper, but there is still hope. I expect Bank of America to move fast when the market jumps aboard considering it is undervalued. The options are cheap - that is why I would be willing to commit to that expectation. I say cheap because the risk-reward is right for me. I might even go with a long position as long as it is below $10, but this would be a modest position. Bank of America has been stuck around $9 for a long time. I have been watching it and it is frustrating. However, it could be time for a move. No clear trends but the fundamentals are turning positive and that is a good sign. There is a risk in trying to get in early, but the reward commensurate with the risk in my opinion.
Bank of America is also lower than Citigroup in absolute terms. I always like stocks that I feel have solid fundamentals that are both undervalued relatively and cheap absolutely. For those you who are more conservative the next round of the tournament will be between Wells Fargo and JPMorgan Chase. These two are not undervalued, but have the potential to grow business. Obviously they are not growth stocks, but they can increase revenues and acquire smaller banks. They can do all the things that banks do to bring in more money. Stay tuned.
Additional disclosure: It will be over 3 days before I jump into anything. As always do your own due diligence.