This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

Who's hot, who's not -- in banking stocks
As winter winds down, and spring is in the air, a young investor's heart turns to love. And like teens experiencing their first high-school crush, there's nothing so cute as bankers in love.

Earlier this week, a mysterious European gentleman caller with the initials "UBS" came a-courting American "banker next door" Citigroup (NYSE: C  ) . UBS upgraded its swain from like to love. (Actually, it went from neutral to buy, but that's not nearly as poetic.) And defying the notion that "you can't put a price on love," UBS went ahead and did just that, arguing that Citigroup is worth $62 a share, or about a third more than Citi shares currently cost.

So what's got UBS (NYSE: UBS  ) falling head over heels for Citi? Several things, actually. According to the analyst:

  • Citi has a lot of money "trapped" on its balance sheet today. Money that will ultimately be released to flow back to shareholders in the form of dividends and share buybacks.
  • An improving economy and especially a better housing market could provide "tailwinds" to the company's earnings growth.
  • Alternatively, if the economy sags, and the housing market relapses, then this will hurt earnings at Citi's relatively pricier banking rivals Morgan Stanley (NYSE: MS  ) and Bank of America (NYSE: BAC  ) -- with the result that Citigroup shares begin to look better by comparison.

Result: "Either way, Citi should outperform" its peers, according to UBS.

Penny for your thoughts
So in essence, what UBS is making here is a "heads Citi wins, tails it doesn't lose" argument. Problem is ... I think UBS is wrong about that. Indeed, there's a very real chance that Citi shares will lose out even if the economy does do well.

Why? At the risk of being blunt, because the shares simply cost too much. Consider: Priced north of 19 times earnings today, Citi shares may look attractive relative to the 48 times earnings multiple at B of A, or the infinity-times-earnings ratio at unprofitable Morgan Stanley. But 19 times earnings still isn't a particularly attractive price relative to the sub-13% long-term earnings growth that most analysts project for Citi, and the stock's meager 0.1% dividend yield does little to make up the difference.

What's more, if you look out a year, UBS's suggestion that Citi is selling at a big discount to its peers doesn't seem to hold water, either. Fact is, the bank's forward P/E ratio of 9.0 (based on 2014 earnings estimates) isn't all that much cheaper than the 9.2 ratio at B of A. It's practically indistinguishable from Morgan Stanley's ratio -- also 9.0.

(And before you object that if all these stocks cost only 9 times earnings just a couple years from now, then Citi's 13% growth rate doesn't seem so bad... read this article first).

Meanwhile, if neither of Citi's big rivals are being particularly generous with their dividend payouts either, then B of A's 0.3% dividend yield, and Morgan Stanley's 0.9%, are still both several times the size of Citi's quarterly payments.

The perils of marrying up
Why is UBS making such a big mistake in deciding to recommend a purchase of Citigroup? Possibly the suitor is simply suffering from an inferiority complex about its own stock's poor metrics -- and seeing Citi as more attractive than it really is, compared to UBS.

Unprofitable itself on a trailing basis, and costing more than any other bank named so far when valued on forward earnings (UBS costs 14.4 times 2014 estimated earnings), UBS may be urging investors to "marry up," and pick a better bank to invest in. If that's the case, though, UBS appears to be missing the prettiest rose in the too-big-to-fail garden: JPMorgan Chase (NYSE: JPM  ) .

Cheaper than all the rest, JPMorgan costs only 9.7 times trailing earnings, and only 8.7 times next year's estimates. It's also less risky, inasmuch as its valuation depends less on growth to justify the price. (JPMorgan's five-year growth estimate is only 6.9%). And JPMorgan's stock has the added virtue of paying a bigger dividend yield than the other majors -- UBS included: A whopping 2.4%.

To my Foolish eye, this makes JPMorgan Chase the veritable Belle of the Big Banking Ball.

More on Citgroup
Whether or not you think Citi's shares are cheap, the big bank's balance sheet is in need of more repair, and there's a considerable amount of uncertainty after a shocking management shakeup. Should investors be treading carefully, or jumping on an opportunity to buy? To help figure out whether Citigroup deserves a spot on your watchlist, I invite you to read our premium research report on the bank today. We'll fill you in on both reasons to buy and reasons to sell Citigroup, and what areas Citigroup investors need to watch going forward. Click here now for instant access to our best expert's take on Citigroup.

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9/27/2016 4:00 PM
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