Don't Even Think About Buying Bank Stocks

"Buy when there's blood in the streets."

How many times have you heard that one? If you really want to make a killing in the market, it's one of the best creeds to follow.

Right now, there's no shortage of blood in the banking industry. Almost every bank is stumbling around and aimlessly hoping that their tourniquets will hold until the next day. Forget blood in the streets … we're talking about mangled guts at your doorstep.  

So is it time to back up the truck and buy some bank stocks?

In the name of everything holy, no
Investors right now aren't giving two thoughts to a bank's future income potential; they're solely focused on whether the bank is adequately capitalized -- essentially, whether or not it has enough of a cushion on its balance sheet to be able to absorb future woes.

The simplified version of this calculation is just assets minus liabilities. That's what's left over as shareholders' equity, and it's what a bank relies upon if its assets head south. The caveat here -- and the reason you should be extra careful when looking at bank stocks -- is that not all assets are created equal.

Goodwill, meet badwill
It isn't just capital you should be looking at when valuing banks, but tangible capital. The difference is that tangible capital strips out things like goodwill, trademarks, brand names, and patents. It's not that those assets don't have long-term value, but they mean squat when it comes to being able to cover existing liabilities at a given time, short of selling entire pieces of the company. Try telling your landlord that you don't have any actual cash but that you have a super-cool last name and your friends think you're totally awesome, and you'll understand what I'm talking about.

Furthermore, when we're talking about common stocks, we have to take into consideration the value of preferred shares that take precedence. This is obviously important right now, because so many banks are issuing gobs of preferred shares to Uncle Sam and big investors like Warren Buffett. Since those investors will be taken care of before common shares see an honest dime, it's only fair to strip out their value to gauge what's left for Joe Typical Common Shareholder.

When you take shareholders' equity, exclude the value of intangible assets, and strip out preferred stock, you get a figure we'll call "tangible common shareholders' equity." This figure essentially represents the buffer between common shares you can purchase in the open market and having those shares be close to worthless.

With that in mind, check out these big-name banks:

Data as of the most recent quarter available in Yahoo! Finance. Does not include preferred shares issued by Treasury in October.
*Not necessarily a bank stock, but still has a substantial finance arm.

Just don't do it
When you look at that table, it becomes apparent why a company such as Citigroup can be down 75% year to date, even after receiving two infusions of government preferred shares. You can essentially think of Citigroup's common stock as an investment in a hodgepodge of assets littered with collateralized debt obligations, mortgage-backed securities, and who knows what else, all levered up roughly 58 times over. If that sounds attractive to you, enjoy the ride. These companies are still utterly leveraged to the gills.

None of this is to say that all, or even any, of those companies will end up making poor investments. Some could easily end up being bargain buys at today's prices. Still, the obvious risk that still lies in these common stocks is just ridiculous. What's as important today as it's ever been is that investors remember about return of capital, rather than just return on capital.  

For related Foolishness:

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• This Is Why Buffett's Buying Stocks