In the upcoming year I expect revenue growth for banks, despite the offsetting effect caused by high regulatory costs. Days ago, the head of the Basel Committee on Banking Supervision said that he expects a tightening of global rules regarding how banks determine the riskiness of their banking and trading book assets for the purpose of determining their regulatory capital reserve requirements. So let's take a look at two banks and see which one is doing better and thus stands as the best investment.
Under the Umbrella
Citigroup Inc. (NYSE:C) is a diversified financial services company that provides a wide range of financial services to consumers and corporate customers in more than 160 countries. The company currently operates in two business segments: Citicorp and Citi Holdings.
In March 2013, Citigroup´s Comprehensive Capital Analysis and Review (CCAR) capital plan was approved by the Federal Reserve. This is an annual exercise to ensure that institutions have sufficient capital to continue operations throughout times of economic and financial stress. These "stress tests" forecast that Tier 1 common capital ratio would remain high at 8.3%, even after a severe recession and trading losses. With respect to the capital, the plan included a $1.2 billion share repurchase program through the first quarter of 2014, but left the quarterly common stock dividend at $0.01 per share.
Citigroup second quarter 2013 net income was $4.182 billion, up 42% from a year earlier, including $5.12 billion from Citicorp (up 18.8% from a year ago), and a loss of $934 million from Citi Holdings. A good portion of the revenue came from outside the U.S. The bank is seeking growth opportunities in Asia, Latin America and other emerging markets.
In terms of valuation, the stock sells at a trailing P/E of 12.5x, trading at a discount compared to an average of 13.5x for the industry. Analysts’ expectations imply a forward P/E of 9.61. To use another metric, its price-to-book ratio of 0.8x indicates a discount versus the industry average of 1.04x and the price-to-sales ratio of 2x is below the industry average of 2.68x.
The Nation’s Largest Bank
JPMorgan Chase & Co (NYSE:JPM) is a leading global financial services company that has assets of nearly $2.4 trillion, with operations in more than 50 countries.
Bank's 2008 Purchases
In May 2008, JPMorgan acquired Bear Stearns in a stock-for-stock exchange. Few months later, the bank purchased all the assets and certain liabilities of Washington Mutual expanding business in California and becoming the nation’s biggest bank by assets and deposits. But this was not costless, legal issues and penalties for mistakes made by both entities could affect the bank’s performance due to high costs of a future settlement. This legal risk is important and it appears that JPMorgan has to take adequate steps to assume the legal liabilities.
$6 billion Stock Repurchase Program
The company won conditional approval of its buyback and dividend plan in March from the Federal Reserve. Also, it announced its third-quarter dividend of $0.38 per share, the same rate it paid last quarter after raising the payout to investors 27%, from $0.30 per share. Due to litigation charges there is a potential suspension of the share repurchase program that could impact the share price.
Its P/E multiple on a trailing 12-month basis is 12.2 and the forward P/E multiple is 8.95. The current dividend yield is 2.51%, which is quite good to protect the purchasing power. We can appreciate that both companies carry discounts to the industry average of 13.5x P/E. These valuations might attract investors.
Finally, I always like to see of one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity.
|Company||ROE||Compared to Industry Mean (=6.9)|
While JPMorgan ROE of 10.4% is above the industry mean of 6.9%, Citigroup's low ROE is not attractive. It is very important to understand this metric before investing in a high-growing company. The following graph shows the evolution of the ratio in the last 10 years. It can be seen that the ratio remains relatively stable in the case of JPMorgan.
Last year JPMorgan faced significant costs for their operations in London (“London Whale”). Although its performance did not change compared to 2011, its reputation suffered. The impact was offset by the release of provisions. Despite the litigation costs, JPMorgan's core businesses look strong and it is estimated that the bank has made improvements in its corporate governance. The firm reported a quarterly profit of $1.42 per share excluding legal costs, beating Wall Street's estimates.
For a long-term perspective, both banks are a buy, but I would advise fundamental investors to consider adding JPMorgan to their portfolios, as it seems to be a more attractive option for the longer term.
Hedge fund gurus like Ray Dalio, Richard Snow and Charles Brandes added JPMorgan stock to their portfolios. Should you too?
Disclosure: Damian Illia holds no position in any stocks mentioned.