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Bull/Bear Report -- Is it Time to Buy Citi?

Owning a bank used to be so simple. Borrow money at a low rate, lend it at a higher rate and profits would surely follow.

But, what happens when you lend at a higher rate and they don't pay? Even worse, what if you borrowed at a higher rate, lent at a lower rate and they still didn't pay?

Then in order to goose returns you participated in a complex pyramid scheme that promised to pay you high returns for low risk. Sounds like a recipe for disaster to me.

And, what a disaster this has been for the entire financial sector. The easy money days are gone and cleaning up from the mess is proving to be more difficult than imagined.

The collapse of the mortgage market has led to a global financial crunch not seen in decades if ever. Nobody knows where it will stop and the decimation in shareholder value has been fairly complete.

Does that mean its time to buy Citigroup (C)?

Learn what our bloggers have to say about this stock.

I posed that question to InvestorPlaceBlog participants for this week's Bull/Bear Report. The responses seem to suggest that these are extraordinary times whereby the old rules of buying beaten down stocks go by the wayside.

One insightful commenter, Rebecca Witwer, posted this thought, "Ordinarily I'd agree with you and consider investing in the laggard areas of the market, but I'd advise strong caution in this area because of the continued write-offs in the banking sector."

Every lesson I have learned regarding valuation from experience to the classroom tells me that now is a great time to be building a position in Citigroup. Global leader with license to print money, strong dividend, and weakness in share price due to asset write-downs all suggest better things to come down the road.

Most of you seem to think differently. The sheer complexity of the breakdown in the credit market may be enough to give pause, but seriously if banks fail we are in deep you know what.
To me that means there will be incredible pressure to find a solution that allows these banks to survive and thrive. A steep yield curve will help the most and the Federal Reserve is doing all it can to produce it.

Maybe a big government eraser would do the trick making all these problems disappear. Will the banks find the miracle that Republican Presidential candidate, Mike Huckabee now seeks?
It is refreshing to see such Rational restraint in the InvestorPlaceBlog community. I honestly had a hard time finding a true Bull case for Citigroup and finally settled on RD's Picks. Essentially he is suggesting caution and if you must buy Citigroup do so in increments over time.

A dollar cost averaging strategy here does seem to make the most Rational sense. The rest of you were fairly bearish on Citigroup deciding to wait for the dust to settle. Here are the two viewpoints:

Bull Case - Russ of RD's Picks,

Our question of the week asks if Citigroup (C) is a screaming buy. The stock certainly seems to be trading at a substantial discount to the market with a forward PE of 7 and price-to-book value of a little over 1. But, we need to look and see if that discount is warranted before placing any buy orders.

C and most other financial firms have had huge write-offs for bad mortgage loans over the past six months or so. In Citi's case, there's also a new CEO on board and we don't know what changes Mr. Pandit might make going forward or what new gremlins might be hiding on the balance sheet. Even though there have been substantial write-offs, there's no guarantee that the mortgage market has bottomed or that other consumer credit or commercial loans won't fall into the same swamp of defaults and uncertainty.

We also need to compare Citi to its competition to see how the valuation stacks up.

C does trade at a discount to the competition, but not a substantial discount. In this market, I'm very skeptical of forward earnings estimates and book values for financial firms. In Citi's case, I believe the uncertainties associated with a new CEO and what's on the books from the previous management warrant the discount to the competition. Citi cheap? - maybe. A screaming buy? - no.

Even though they trade at a premium, JP Morgan or Wells Fargo look like better investments to me. WFC and JPM haven't had as much bad news as some of the other banks and seem to have done a better job of managing credit risk. JPM looks cheap on book value and Wells' ROA and ROE look downright stellar in comparison to the others. All of these banks offer dividend yields above 5-year treasuries - a good deal for income investors IF they don't have to cut the payout. Bank of America, Wachovia and Citi's dividend yields are at a level that indicates the market is pricing in a significant risk of a dividend cut.

Citi offers more potential reward than other banks IF the worst is behind them. At current prices, that reward seems matched with higher risk. And, I suspect there will be some more stumbles along the way to recovery.

For any of these names, I wouldn't be backing up the truck. It might still be early, but nibbling on dips to establish a position makes sense. I think the credit markets will stay foggy and continue to offer occasional buying opportunities for some time.

In short, a trip to the Citi is a little more risk than I care to deal with.

Disclosure: I hold WFC both in SLO and real life. That hasn't been a lot of fun lately, but gradually buying on dips recently was profitable and the dividend payments help ease the pain.

Bear Case - John Freeman, Uncle John's Cabin,

In answer to the question of the week, Citigroup is only a screaming buy if someone held a gun to my head and made me buy it while screaming for my life. Even then I might consider it for a while first. /grin

There are a number of reasons I would stay away from this stock at this time.
First, just because it's down doesn't make it a value. For better or worse, the big (C) is going to feel some pain for a long time to come but most certainly in the next quarter or two. Typically if I were going to buy into a distressed sector like this I would lean towards best of breed here and baby, Citi just ain't one of them.

I have to consider Gold Pants Slacks, umm, oops, (GS) and possibly (UBS) as best of breed in this sector (unless you want to count the regional banks, which I might prefer.) Given that, seeing the excessive writedowns UBS just had to take leads me to believe yet another round of very large writedown are in the making.

New leadership. I don't know how Pandit is going to run this ship. He says he doesn't want to break the company up and thinks the synergies are good. Maybe he's right, maybe he's wrong but the company's businesses do look a little bloated to me. A little streamlining and getting back to basics is what most of these banks need right now IMHO.

Certainly the analysts don't like it. The techinicals are not good for short and intermediate trends and still, nobody really knows exactly what is on their books.

Could Citi just skyrocket up? Is it undervalued? Yes and probably. But, for the next few months, C is really just a lottory ticket and quite honestly, I don't like gambling when the government is involved. I play poker, even go to Vegas but I won't play if they can change the rules mid-game. How do you know the true odds on your bet when DiNallo, congress and even the NY state governer are trying to change the rules? The only bet I'm making is more writedowns and more pain next quarter while the politicians jockey for votes.

Well, I guess the banks almost always make money long term and the government's position is to make sure that happens which is fine. Bernanke has ensured a steep curve between the 2 and 10 year notes and we will likely see more cuts to come which will always favor the banks in the long run. If you buy and hold for 2+ years I'd bet that you'll make out just fine.

There are 2 things I personally need to see before I put any long term money into Citi or any other bank right now and those are a permanent resolution to the monoline and CDO issues and one good quarter in the books. I will probably miss the bottom by then but whats the hurry? I have enough gashes in my hands from trying to play the "catch a falling knife game" right now.

Good luck to all,
Uncle John

My personal bias is to favor the bull case here. I do find it hard to believe that there is much more bad news on the horizon. The Federal Reserve and the government will do everything in its power to ensure that the banking system survives and thrives.

That effort may explain the huge selling in the U.S. dollar and rise in gold prices. Put it all together and it is clear that this mess does not resolve over night. That means establishing your position in Citigroup over the next 12 months may be the best approach.

Jamie Dlugosch,
Executive Editor, InvestorPlace Blogs

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Posted on February 22, 2008 6:13 PM | Permalink

Comments (1)

Uncle John

Just curious Jamie, how do you feel now about Citi?

Uncle John

Posted by Uncle John | March 14, 2008 7:14 PM

Posted on March 14, 2008 19:14

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Bull/Bear Report -- Is it Time to Buy Citi?

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