‘Rotation’ is a commonly-used term among investment professionals, and one that may draw your attention in the quest for stock market success.
In the world of stocks, rotation often takes place between market sectors. For example, investors often rotate away from consumer staples such as Dollar General Corp. (NYSE:DG) in favor of consumer discretionary stocks such as NIKE, Inc. (NYSE:NKE) in a recovering economy.
Rotation can also take place within a sector.
In the wake of the 2008-09 credit crisis, financials outperformed the S&P 500 index by a wide margin as the Federal Reserve laid the groundwork for a banking recovery.
The third largest bank by deposits, Citigroup Inc (NYSE:C) has earned a new level of attention with the resignation of longtime CEO Vikram Pandit and with Michael Corbat’s succession. The stock has outperformed so far in 2013 with a 21.7% gain compared to only 13.1% for the S&P 500. The bank has also posted a larger YTD return than Wall Street competitors JPMorgan Chase & Co. (NYSE:JPM) and Goldman Sachs Group Inc (NYSE:GS).
Here are four reasons why readers should rotate into Citigroup Inc (NYSE:C) for the second half of 2013:
- On July 1, Citigroup Inc (NYSE:C) announced a formal settlement of $968 million with FANNIE MAE PFD S (OTCBB:FNMAS) to resolve mortgage repurchase claims, removing a large overhang from the stock. The agreement removes the threat of future litigation pertaining to bad loans that originated from 2000-2012, giving investors more clarity on the bank’s earnings power going forward.
- In Europe, Citigroup Inc (NYSE:C) is poised to capitalize on increased regulatory burdens facing its European domiciled peers. Competitors such as German-based Deutsche Bank AG (USA) (NYSE:DB) need to adapt to new standards that restrict employee compensation and limit after-tax profits. Citigroup Inc (NYSE:C) will be advantaged to offer lower-cost services and capture market share over time.
- Unlike American banks, Citigroup offers exposure to high-margin loan growth in Asia, Latin America, and other emerging nations. These markets are outside of the persistent low-interest environment here in the United States and the Eurozone. Citigroup is also a natural play on the globalization of business activity.
- Given it’s improved financial position and 9.3% Tier I common ratio, Citigroup management is likely to propose a significant dividend increase and share repurchase plan for fiscal 2014. A 30% payout of first quarter 2013 earnings would equal $0.37 ($1.23 Q1 EPS x 0.30), a $1.48 annualized dividend payout and 3.0% yield based on recent market prices.
In addition to the above positives, Wall Street is becoming increasingly bullish on Citigroup. On June 13, research analysts at Credit Suisse issued an “outperform” rating and $60 price target on the stock.
A difficult investment banking environment
In April, the NYTimes Dealbook published an article titled The Problem With Investment Banks, as Seen By a Bank. The Times centers on a research note published by JPMorgan Chase & Co. (NYSE:JPM) analysts ahead of the bank’s Q1 2013 earnings call, which states “We see Tier I investment banks as non-investable.”
The report published by JPMorgan Chase & Co. (NYSE:JPM) advises its clients not to buy stock in competitors such as New York-based Goldman Sachs Group Inc (NYSE:GS) and German giant Deutsche Bank AG (USA) (NYSE:DB), but falls short on a buy/sell recommendation for JPMorgan Chase & Co. (NYSE:JPM) investors. All of these companies are considered to be Tier I investment banks.
If you’ve followed my writing at the Fool, you’re probably aware that Goldman Sachs Group Inc (NYSE:GS) and JPMorgan Chase & Co. (NYSE:JPM) dominate the investment banking business.
The tandem frequently compete for the highest-ranked spot for deal volume and number of transactions completed. Therefore, you can probably read between the lines that if JPMorgan Chase & Co. (NYSE:JPM) advises not to invest in Goldman Sachs Group Inc (NYSE:GS), it’s most likely not a good idea to invest in JPMorgan as a corollary.
Finally, data from Thomson Reuters indicates that mergers & acquisitions (M&A) deal volume was the lowest in terms of dollar value during the first half of 2013 in the last four years. For the reasons above, I am lukewarm on JPMorgan and Goldman Sachs Group Inc (NYSE:GS) for the remainder of the year.
Valuation
| Citigroup | Goldman Sachs | JPMorgan | |
|---|---|---|---|
| Market Cap $ | 141.5B | 69.0B | 199.5B |
| Ann. Dividend/Yield | $0.04/0.08% | $2.00/1.33% | $1.52/2.88% |
| Beta | 2.6 | 1.4 | 1.3 |
| Short Interest | 1.38% | 1.41% | 1.17% |
| Book value | $62.51 | $148.41 | $52.02 |
| Price-to-book | 0.76x | 1.01x | 1.01x |
| FY 2013 EPS | $4.72 | 14.39 | $5.74 |
| 2013 P/E Ratio | 10x | 10.5x | 9.2x |
| FY 2014 EPS | $5.43 | 15.28 | $5.98 |
| 2014 P/E Ratio | 8.8x | 9.8x | 8.8x |
| YoY Earnings Growth | 15% | 6% | 4% |
Let’s compare the valuation among the three banks. Based on full-year earnings of $4.72 per share, Citigroup is trading at a discounted 10x price-to-earnings multiple.
Citi’s 2014 earnings are expected to climb 15% to $5.43 per share, offering long-term investors a great opportunity at less than 9x the bank’s 2014 estimates. In contrast to 15% growth at Citi, Goldman Sachs Group Inc (NYSE:GS) and JPMorgan should grow earnings at only 6% and 4% respectively.
Also take note of the annual dividend payouts. Citi investors will benefit from a dividend catalyst, while the dividends at Goldman Sachs and JPMorgan are fully priced.
On a book value perspective, Citigroup shares are the least expensive at 0.76x price-to-book.
Foolish takeaway
The performance of the largest financial stocks may diverge in coming months as the banking industry enters a new cycle. For once, diversification outside the United States can be a good thing.
Readers might consider Citigroup based on its attractive valuation and global footprint. The recent settlement with FANNIE MAE PFD S (OTCBB:FNMAS) is a bigger deal than the market realizes, and will allow management to focus on core profitability. And unlike its peers, Citigroup investors should benefit when the bank restores its dividend to normalized levels in 2014.
In contrast to Citigroup, competitors JPMorgan and Goldman Sachs appear fully priced. Investors should heed their attention to the troubled investment banking environment, which could undermine profitability.
John Macris has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs. The Motley Fool owns shares of Citigroup Inc (NYSE:C) and JPMorgan Chase & Co (NYSE:JPM).. John is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Four Reasons to Buy Citigroup and Sell JPMorgan, Goldman Sachs originally appeared on Fool.com is written by John Macris.
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