Citigroup (NYSE: C) has seen its stock price drop about 36% this year, to around $51 per share at Monday's close. That's quite a sell-off -- but does that make Citigroup a good value?
A value stock is one that's underpriced relative to its revenue, earnings, and other fundamentals due to temporary factors. An investment in an underpriced stock is typically made on the premise that it will revert to its intrinsic value and reward patient shareholders. If the stock does not bounce back due to other more permanent issues, then that's considered a value trap.
So, is Citigroup, at its bargain-basement price, a value or a value trap? Let's take a look.
Citigroup is the fourth-largest bank in the country, with $2.2 trillion in assets as of June 30. Its deflated stock price is typical of its industry, as all banks have been hit hard by the pandemic. Not only has a benchmark interest rate near zero hurt net interest income, but banks -- particularly the big banks -- have been devastated by large provisions of credit losses to cover expected loan losses due to pandemic- and recession-related hardships. The banking industry is down, on average, 34% year to date, so Citigroup is right in that ballpark.
There are some promising signs within the company that indicate it is indeed a value.
First, despite setting aside $5.6 billion for credit losses, the company still managed to post $1.3 billion in net earnings in the second quarter, as revenue rose 5% year over year to $19.8 billion. Among the major banks, only JPMorgan Chase had a higher revenue increase.
Citigroup also managed to reduce expenses by 1% year over year. This helped the firm reduce its efficiency ratio to 52.7%, which is second only to JPMorgan among the big four. The efficiency ratio is an indicator of a bank's overhead in relation to its revenue -- so the lower, the better.
In addition, Citigroup posted a 2.4% return on equity in the quarter, which is below the industry average of 3.2%, according to first-quarter data. However, the bank improved its capital strength in the second quarter, raising its common equity tier 1 ratio to 11.5% from 11.2% in the first quarter, well above the 10% regulatory minimum.
Good book value
A key indicator of a bank's value is its book value, which measures its total assets minus liabilities. It gives a more complete representation of a bank's intrinsic value. Citigroup's book value per share jumped 5% in the second quarter to $83.41. That indicates the bank is worth much more than its share price would indicate.
The price-to-book (P/B) ratio, which is calculated by dividing stock price by book value per share, was 0.61 at Monday's closing price. A price-to-book ratio of 1.0 means the stock price and book value per share are aligned, so a P/B ratio of 0.61 means the stock is trading at a big discount. In other words, the stock price is a good value relative to its book value.
Another key indicator, although not as relevant as P/B for banks, is price-to-earnings (P/E) ratio. It measures the company's share price relative to its earnings per share. Citigroup's trailing P/E is about 8.6, but earnings the past two quarters have been out of whack due to high provision of credit losses. The forward P/E, a metric that is based on future earnings estimates, is 15.7, which means growth prospects are expected to improve.
Based on these numbers, Citigroup definitely looks like a good value for investors. However, be cautious, as a significant gain in the stock price will be tied to an economic recovery from the recession, so it's best to watch and wait for signs of recovery over the next few quarters.
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Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
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