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Looking Pretty in the Citi

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It's a tough crowd, Citigroup (NYSE: C  ) .

Citi shares fell more than 6% yesterday after reporting quarterly earnings. Investors weren't impressed.

It's easy to see why on the surface. Quarterly profits came in at $1.3 billion, or $0.04 per share. That's trivial even for this $5 stock and not enough to reinstate a healthy dividend like JPMorgan Chase (NYSE: JPM  ) is talking about.

But dig a little deeper, and things actually don't look half bad.

This quarter's earnings were hit by a $1.1 billion accounting charge tied to the tightening of Citi's own bond spreads. This is the flip side of an asinine accounting rule that banks used to juice earnings during the credit meltdown two years ago. Back then, bankruptcy looked like a real possibility, and the value of banks' debt plunged. Assuming they could theoretically buy their own debt back on the cheap and book the difference as income, banks and their accountants went ahead and did so. Now that bank debt is increasing in value as the economy recovers, those phony profits are being reversed.

Put simply, the same accounting rules that made bank profits look artificially good two years ago are now making them look artificially bad.

Without the accounting charge, Citi would have earned around $2.1 billion, or about $0.07 per share. That's $0.28 per share annualized, which works out to a roughly 6% earnings yield on its current share price. Assume a 50% payout ratio, and Citi could probably afford to pay a 3% dividend if these earnings keep up. Not bad. 

It gets better. Citi's credit quality is improving at the speed of sound. Nonperforming loans fell 36% in the fourth quarter from the same period a year ago. Allowance for loan losses as a percentage of nonperforming loans -- the cushion for future losses -- stands at 209%, up from 114% a year ago. JPMorgan's comparable ratio is 190%. When Bank of America (NYSE: BAC  ) reported results last quarter, its same ratio stood at 135%. When preparing for bad weather, Citi is in a league of its own among big banks.

And keep in mind how far these guys have come. It wasn't but two years ago that many, including myself, were sure Citigroup was toast. Now here it is earning more than $10 billion for 2010, making it one of the most profitable companies on the planet. Granted, this has been on the back of unprecedented bailouts and fiscal stimulus. But as CEO Vikram Pandit told employees yesterday, "A year ago, no one would have believed we would have been able to accomplish what we have." And he's absolutely right.

Fool contributor Morgan Housel owns Bank of America preferred. The Fool owns shares of Bank of America and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (7) | Recommend This Article (39)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 20, 2011, at 3:46 AM, Clint35 wrote:

    Thank you, Morgan. I was starting to think I was the only person in the world who thinks Citi has made big improvements. I think it's actually become a decent company and at this low price it's a pretty good investment.

  • Report this Comment On January 20, 2011, at 9:57 AM, sglisson wrote:

    So, here's my question then . . . I'm still sitting on a load of Citi shares I bought pre-banking debacle. (BAC, too.) Would you recommend I buy more to average down my price, hold them and hope they grow to those 2008 prices, or chunk 'em and buy AAPL?

  • Report this Comment On January 21, 2011, at 1:26 PM, multi007 wrote:

    @ sglisson

    I would buy to average down. They wont go bankrupt now after the ballouts and as employment and loans improve, so will the stocks. But make sure you are thick skinned... a drop of 20% can happen any day even into good news.

    But I believe the payoff will be good enough for me to invest 25% of all new cash I earn monthly to buying more C and BAC.

    PS. Im 37 years old. Young enough to tolerate and recover from a loss.

  • Report this Comment On January 22, 2011, at 12:37 PM, buckeyes2 wrote:

    How many consecutive days must Citi stay above $5 for fund managers to start buying in?

  • Report this Comment On January 22, 2011, at 11:04 PM, Blueman1000 wrote:

    I'm an independent investor and I simply don't have the skills to lay it out the way this article does. I've researched and I've seen the profits, the turn around the growth overseas and more. This article is great and I've copied it and am studying it. Over the months I at one point thought about selling my AAPL stock (only 120 shares) that I bought when they were 85.00 per and put it all in Citi. This company has turned a very sharp corner and I see great things ahead. Thanks.

  • Report this Comment On March 12, 2011, at 8:52 PM, Blueman1000 wrote:

    This is really a great article, I'm not sure why there hasn't been more comments. I've saved this information it's a great resource to research, thanks again. Now with Citi's earnings reports coming up what sort of numbers to you think they'll hit?

  • Report this Comment On September 23, 2011, at 9:54 AM, jargonific wrote:

    So you guys created a real PR success story. Except that it just flopped over and took a lot of people's savings with it after investment firms put CIti in their portfolios. Disaster, inside trades, speculation, and short selling clubs merging with hedge fund managers and politicians...that's what got us into this depression baby, and we're in one now. Citi? Ha. Read Ron Suskind's book.

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