Valuing banks is always difficult no matter how you look at them. Black boxes to the majority of investors that can hide numerous skeletons in an infinite amount of closets. Having said that, I decided to add a bank into my portfolio for diversification purposes. The only other stock from the financials sector that I hold is Prudential (NYSE:PRU) which I am long from $76. Based on the operating and market ratios from Bloomberg I took a long in Citigroup (NYSE:C). In this article, I will display some of these statistics and show a valuation comparison among North American and Global banks.
The table below shows the following banking stats:
- NIM: Net Interest Margin: A measure that tells us the net amount earned from loans versus paid out to depositors.
- Efficiency Ratio: Operating Expenses to Net Revenues (Net Interest Income and other income). The lower the better.
- ReturnTE: Return on Tangible Equity : Trailing 12m Profits to Average Tangible Equity
- ROE: Return on Equity
- Tier 1 Common Ratio: The ratio of the bank's core common equity to risk-weighted assets. A measure of capital adequacy of a bank. Defined as Total Tier 1 Capital less preferred, minority interest, trust preferred and hybrid securities. The higher the ratio, the more protected the bank is from unexpected losses.
- CAR: Capital Adequacy Ratio: The ratio of total risk-based capital to risk-weighted assets. In this case both Tier 1 and Tier 2 are included.
If you are interested in banking ratios then click here for a 8-page document from Moody's. The data below was taken from Bloomberg. Specifically I focused on the group "Diversified Banks" on a global scale. Based on my analysis and regression work this group had the strongest relationship and so ignored other types of companies within the financial sector (such as brokerage, investment banks, asset managers, consumer finance, etc).
On a global scale, C has higher capital adequacy ratios, higher net interest margin and is more efficient with lower costs to revenue. It falls behind though on returns (ROE is 7.4% vs 10% for the average). So is the lower valuation justified? To answer this I looked at the following relationships: Price to Book vs ROE, Price to Tangible Book vs RoTE, Price to Tier1 vs RoTE. The regression plots along with the equations and R-squared are shown below: You will notice there is a fourth plot in the bottom right corner. I decided to place some emphasis on P/Tangible book. This is because a) Price to Book and ROE did not produce the best relationship, and b) Price to Tier 1 had fewer observations to work with. The bottom right plot is essentially the same as the one above with the exclusion of two data points. This has the highest R-squared from the above regressions.
Regardless, the outcome doesn't change by much. I calculated the multiples that each of these banks could trade at based on the regression equations. The table below shows the upside from the current market multiple.
All of the regressions produce a single digit upside figure for C. Not very exciting but at least its in the top 1/2 of global banks. Investors interested in Europe may want to take a look at the European banks shown above (BNP Paribas (OTCQX:BNPQF) and Societe Generale (OTCPK:SCGLF)).
The same exercise was done for North American banks. Below is the table with the stats.
The regression plots are shown below for North America.
Finally the potential upside based on these regressions are:
Based on North American banks, C has much more upside than when compared to globally. After a favorable review in last year's stress tests, C was able to increase its dividend from 5c to 16c per quarter. Its buyback program was until recently in excess of $10bn, while the company returned $11bn to shareholders in 2016 via dividends and share buybacks. It's global reach differentiates it from other banks as it has a significant presence in Emerging Markets. Its size and reach make C attractive global businesses while allowing it to participate in growing economies. From a risk perspective, this global presence could however result in some bumps along the way.
C is definitely not the cheapest stock you can find, however if an investor is thinking about adding some financial sector exposure then C is a candidate that should be considered.
Disclosure: I am/we are long C, PRU.
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.