Citigroup stock: undervalued with chances of double-digit returns

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Introduction

Despite a recent beating in Q2 2022 earnings and news of Berkshire Hathaway acquiring a substantial position in the company for a total of around $3 billion, the past few months have not been kind to investors. company shareholders.

The the stock remains around 40% below its 2021 high and is currently at a similar market capitalization to what it was a decade ago.

The company name is, of course, Citigroup (NYSE:C). An American multinational investment bank with +223,000 employees spread across the world. The company is the fourth largest financial institution in America and is currently ranked #141 on the prestigious Fortune 500 list.

Capital allocation

Paying attention to how Citigroup allocates capital is especially important because, as we will soon realize, company valuation is a major determinant of the company’s organic growth rate. Like other major US banks, reinvestment in new assets and therefore in equity is not a priority. Given the size of the company and the low return on invested capital from options, share buybacks have been and continue to be beneficial.

As shown in the image below, the amount of equity has remained stable in recent years. Return on equity has averaged around 6%, increasing after the reduction in equity due to the one-time “federal tax bill” charge in 2018. I think it’s reasonable to expect what the company continues to earn about 7% on equity, assuming it doesn’t start building new equity each year.

Citigroup return on equity and total equity

Return on equity (Macrotendances.com)

Although the company is unable to repurchase shares at this time due to capital requirements, they will soon be reintroduced. Given that the company currently pays around 30% of its earnings in the form of dividends, it is reasonable to expect that once the required capital requirements have been met, the rest will be used to buy back shares. These buybacks could increase book value by 11.7% per year, which in itself is a respectable return and well above its average growth of ~6.5%. Profit used on the dividend currently yields 4.13%, bringing the total annual return to 15.83%.

Despite the fact that the stock is valued below book value, this in itself is not necessarily a sign of a cheap company. What matters is how much the business earns relative to its equity and how efficiently that capital is used. Many banks can be valued at their book value, but the return on equity is also higher than Citigroup is capable of. A price-to-book ratio of 0.47 seems low, however, for a company earning ~7% on equity.

BVPS and PV

Book value per share (Macrotrends.com)

Earnings per share

Given that growth per share is on the lower end, I’m not surprised to see that the average multiple was below the norm of 15. Citigroup averaged earnings growth per share of around 6, 2%, which is very close to the average BVPS growth rate of 6.5%, as mentioned earlier. Given that their valuation is significantly below normal, stock price growth will likely continue to rise. Likewise, the dividend will continue to become more attractive.

Citigroup averages a multiple of around 11, suggesting upside potential of around 78%.

Citigroup operating profit

C Operating Profit (Fastgraphs.com)

Stock chart

Quick disclaimer. Technical analysis on its own is not a good enough reason to buy a stock, but when combined with company fundamentals, it can significantly narrow your target price range when buying.

With companies growing steadily, it’s not uncommon for the 50-month moving average to be where the support is often found. This was true many times before the financial crisis and was also true after the crisis. There have been times when fundamentals have shown signs of being undervalued, just as they are now. I believe this time is no different as long as the business continues to operate as it has been and most likely will continue to do so.

A return to the moving average would indicate an upside potential of around 32%.

Citigroup monthly stock chart with 50-month moving average

C monthly stock chart (Tradingview.com)

Final Thoughts

Citigroup’s expected return depends on the market value of the company. This is because dividend and buyback benefits increase the longer valuations remain suppressed. I don’t think the company should be trading at book value. However, I think a price-to-book ratio of 0.47 at the same time is too low. It is lower than its average price-to-book ratio and is not something you can find with other banks that have the same ability to reinvest.

A return to a healthy price-to-book ratio of around 0.7 would indicate 50% upside potential. A return to an appropriate multiple would indicate upside potential of around 78%, and a return to a price slightly above the 50-month moving average, which has been the norm between occasional declines, would indicate upside potential of around 78%. about 52%.

How long it will take for the valuation to correct remains to be seen, but one thing is certain. The underlying intrinsic value of the business will continue to grow and buyouts, once pursued, will only accelerate this process.

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