When it comes to stock-picking, it's not always about finding
the best company in an industry. It's about finding the best stock
in that industry.
I was reminded of that axiom after poring over first-quarter
results from
Wells Fargo (
WFC
)
,
JP Morgan (
JPM
)
and
Citigroup (
C
)
. The first two banks have been the class of the field. Citigroup
remains in "clean-up mode" as it emerges from a number of
self-inflicted wounds from the lastrecession . Still, Citigroup has
potentially much more upside than those better-run banks, which is
why it's a member of my
$100,000 Real-Money Portfolio
.
At first blush, investors are understandably attracted to
Wells Fargo and JP Morgan. Warren Buffett has owned Wells Fargo for
much of the past decade, rightly acknowledging a solid management
team that avoids the worst of the industry's excesses. And JP
Morgan is one of the few major investment banks to
successfullycapitalize on the weakness seen by rivals such as
Citigroup and others.
Citigroup, for its part, has seen its capital base come under focus
because it has been slow to shed assets that are no longer core to
the bank's future direction, such ashedge fund management. A recent
brush-back by regulators after Citigroup applied for permission to
boost dividends and buybacks was just another blemish for this
erstwhile banking giant. Indeed, Citigroup's need to retrench to
shore up itsbalance sheet has led it to now have a slightly smaller
revenue base than Wells Fargo, and it's now only two-thirds the
size of JP Morgan. Five years ago, Citigroup had the largest
revenue base.
Moreover, Citigroup is only slightly cheaper than those other two
banks when comparing price-to-earnings (P/E) ratios. In most
instances, it pays to pursue an industry's better operator if
itsshares are only slightly more expensive. (Arguably, all three of
these bank stocks are quite appealing in terms of P/E ratios, as
currentearnings are quite depressed compared to what they might be
by the middle of the decade.)
Yet in one respect, Citigroup is simply far too cheap to ignore.
Shares
have risen more than 50% since bottoming out last November, but
they still sell at a considerable discount to tangiblebook value
.
Even as the stock price has rebounded, so has tangible
book value
. Assuming that Citigroup is slow to reinstate a more
robustdividend , tangible book value looks set to keep on rising at
fast pace. (Dividends eat into book value.)
In just the last eight quarters, Citigroup has boosted tangible
book value by 31.5%. And that's in a still-weakeconomy . At current
trend rates, analysts think tangible book value will approach $60 a
share by the end of 2013. As I've noted in the past, stocks can
often trade below book on a short-term basis due to near-term
investor concerns (in this case, European exposure, which is
actually fairly limited for Citigroup). But that gap tends to close
over longer periods.
It's also worth noting that the healthier bank stocks trade at a
premium to tangible book. Indeed, banks have tended to trade
between 1.5 and 2.0 times tangible book for much of the past 30
years.
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The subpar valuation for Citigroup implies that the bank has
inferior growth prospects relative to Wells Fargo, JP Morgan and
others, but that's simply not the case. As I have noted in previous
updates, Citigroup has been dedicating a significant amount of
resources towards expansion in Asia and Latin America, right at a
time when major European banks, which have typically had a strong
presence in those high-growth regions, are pulling capital out in
order to shore up their operations back at home. Citigroup is
getting little credit for these forward-thinking moves right now,
but it will.
Risks to Consider:
Although Citigroup's exposure to Europe is fairly limited,
problems in that region could still weigh on bank stocks in coming
quarters.
Action to Take -->
A clearcatalyst exists to finally get this stock rolling: Citigroup
will re-submit itsfinancial statements for a stress test in June,
with a response from regulators due later in the summer. A green
light, which is likely will now that its capital base is even
stronger than before, should pave the way for a bigdividend hike
and/or a large stock buyback plan. Indeed, any time you see a stock
selling well below tangible book value, then buybacks should be the
preferred choice.
To be sure, Citigroup will need more time to restore its
credibility with many investors after needing government support
just a few years ago. As long as the U.S.economy grows at a 2% to
3% pace in the next few years, the housingmarket should slowly
return to life, which should help boost Citigroup's results. More
robust growth that is expected from Latin America and Asia should
also help power up thebottom line and punch up book value. For
patient investors, the two to three-year returns for this stock
could handily exceed 50%.
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-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of C in one or more if its "real money" portfolios.