The financials have been on a tear this year and after the outstanding jobs report this morning, they are leading the rally today. I have written several articles on the banks stating that they have gone from being significant underperformers in 2011 to solid outperformers in 2012. Some analysts are stating people should wait for a pullback to get in, a pullback that may never come frankly or may be so quick and shallow you will miss it if you blink. So what to do?
My position is to start a position a quarter at a time on a weekly interval with the bank that is most undervalued by enterprise value to sales ratio (EV/Sales) coupled with having the most upside based on analysts' consensus mean estimated price target.
The EV/Sales ratio is a valuation measure that compares the enterprise value of a company to the company's sales. The EV/sales ratio indicates to investors the cost of the company's sales. This measure is an extension of the price-to-sales ratio, which uses market capitalization rather than enterprise value. The EV/sales ratio is perceived to be the more concise determinant of undervaluation due to the fact market capitalization does not account for debt while enterprise value does. The debt a company has will need to be paid back at some point. Generally the lower the EV/sales ratio is the more attractive or undervalued the company is believed to be.
The following three banks, Bank of America (BAC) with an EV/Sales ratio of 3.51, JPMorgan Chase (JPM) with an EV/Sales ratio of 3.99 and Citigroup (C), with EV/Sales of 8.07 are the three lowest of all the financials today. Now let's look at where they stand in regards to consensus analyst estimated price targets. This will give us an idea of the potential upside left in the stock. This is important because once a stock reaches consensus target estimates, they tend to downgrade the stock based on valuation.
Citigroup leads the pack regarding potential upside with a mean consensus estimated price target of 22 analysts of $42.50 and a current share price of 33.38, Citigroup has 27.3% upside potential. JPMorgan Chase is second with 20.5% upside based on a mean price target by 28 analysts of $46 and a current share price of $38.15. Bank of America ranks third with 14.45 upside based on a consensus price target of $8.90 and a current share price of 7.78.
I chose to go with Citigroup for its significant upside. Additionally, Bank of America and JPMorgan chase were just today sued by the New York Attorney General regarding MERS registered mortgages. The NY AG alleges bank of America, JPMorgan Chase and Wells Fargo used the registry as an "End Run" around the process to securitize loans.
Citigroup Review
Citigroup has a PEG ratio of 0.83, a forward Price to Earnings ratio of 6.51, Price to Book ratio of 0.50 and a projected EPS growth rate of 15.69% for next year. Citigroup is 35% below its 52-week high. These fundamentals are strong. A PEG of less than 1 is extremely bullish. Citigroup is trading at half of its book value. This fact coupled with decent EPS growth and reasonable price performance confirms that C is undervalued, additionally, with an RSI of 64.68 C is technically neither overbought nor oversold currently.
Citigroup's capital levels and book value continued to increase versus the prior year period. As of December 31, 2011, book value per share was $60.78 and tangible book value per share was $49.81, 8% and 12% increases, respectively, versus December 31, 2010. Citigroup's Tier 1 Capital Ratio was 13.6% and its Tier 1 Common Ratio was 11.8%.
Citigroup Inc. recently reported net income of $1.2 billion, or $0.38 per diluted share, for the fourth quarter 2011 on revenues of $17.2 billion. This compared to net income of $1.3 billion, or $0.43 per diluted share, in the fourth quarter 2010 on revenues of $18.4 billion.
Conclusion
One caveat to the financials is over-capacity issues, risk of over-regulation and lack of earnings growth visibility given higher capital requirements will be significant challenges for the sector. If you choose to start a position in any stock, I suggest layering in a quarter at a time on a weekly or monthly basis depending on your time horizon to reduce risk and setting a 5% to 10% trailing stop loss order to minimize losses. Use this information as a starting point for your own due diligence and research methods.
Disclosure: I am long C.
