Warren Buffett attracts a lot of attention. As the world's third-richest person and most celebrated investor, thousands try to glean what they can from his thinking processes and track his investments.
While we can't know for sure whether Buffett is about to buy Citigroup
In his most recent 10-K, Buffett lays out the qualities he looks for in an investment. In addition to adequate size, proven management, and a reasonable valuation, he demands:
- Consistent earnings power.
- Good returns on equity with limited or no debt.
- Management in place.
- Simple, non-techno mumbo jumbo businesses.
Does Citigroup meet Buffett's standards?
1. Earnings power
Buffett is famous for betting on a sure thing. For that reason, he likes to see companies with demonstrated earnings stability.
Let's examine Citigroup's earnings history:
Source: Capital IQ, a division of Standard & Poor's. Free cash flow is adjusted based on author's calculations.
Over the past five years, Citigroup's earnings have fluctuated dramatically amid the financial crisis. Earnings have recovered somewhat, but as with many other U.S. banks, loan growth – which declined 11% last quarter -- remains sluggish.
2. Return on equity and debt
Return on equity is a great metric for measuring both management's effectiveness and the strength of a company's competitive advantage or disadvantage -- a classic Buffett consideration. When considering return on equity, it's important to make sure a company doesn't have an enormous debt burden, because that will skew your calculations and make the company look much more efficient than it actually is.
Investors often use the Tier 1 capital ratio to see how leveraged banks are. The ratio compares a bank's equity and reserves to its total risk-weighted assets. Under "normal" market conditions (no financial panic, non-terrible lending), a ratio greater than 13% is generally conservative.
Since competitive strength is a comparison between peers, and various industries have different levels of profitability and require different levels of debt, it helps to use an industry context.
|
Company |
Tier 1 Capital Ratio |
Return on Equity (LTM) |
Return on Equity (5-year average) |
|---|---|---|---|
| Citigroup, | 13.3% | 6% | 0% |
|
Bank of America |
11.3% | (1%) | 7% |
|
JPMorgan Chase |
12.3% | 11% | 9% |
|
Wells Fargo |
11.5% | 11% | 13% |
Source: Capital IQ, a division of Standard & Poor's.
In today's non-boom environment, Citigroup is producing a modest return on equity while employing a bit less leverage than its peers.
3. Management
CEO Vikram Pandit has been at the job since 2007. Prior to that, he'd worked at Morgan Stanley for a number of years before helping to start a hedge fund that Citi acquired in 2007.
4. Business
Banking isn't particularly susceptible to technological disruption. Obviously, though, it's susceptible to booms and busts.
The Foolish conclusion
Regardless of whether Buffett would ever buy Citigroup (and he's already invested in competitor Goldman Sachs), we've learned that the company doesn't particularly exhibit the quintessential characteristics of a Buffett investment: consistent earnings, high returns on equity with limited debt, and a straightforward industry.
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