Are These 3 Stocks "Cheap for a Reason"?

Photo credit: Flickr/drazz.

Put simply, I think that stocks in the financial sector are cheap right now.

However, there are a handful of banks that trade for substantial discounts to book value, making them look like incredible bargains -- at least at first glance. Let's look at a few of the "cheapest" bank stocks in the sector and see whether they're actually good bargains, or if they're cheap for a reason.

The best value in U.S. banking
Citigroup (NYSE: C  ) is currently trading at around 74% of its book value and is priced below its tangible book value, a historical rarity for banks. Since the financial crisis, Citigroup has taken steps to rid its balance sheet of bad assets, and while it's not quite done, the Citi Holdings division where most of the problem assets are has shrunk considerably.

C Price to Book Value Chart

C price-to-book value data by YCharts

The bank has been growing its deposits and (healthy) loan portfolio, all while reducing net credit losses by 15% over the past year. There has been some weakness recently, particularly in the fixed-income trading business, but this is probably a temporary hiccup.

The temporary weakness caused Citigroup to disappoint the market during its latest earnings report, and its stock price has dropped by about 10% since the report a few weeks ago. I think this dip in price is a great second chance to get in on the best bargain among U.S.-based banks. Citigroup is very cheap, and its valuation more than makes up for any risk. This bank will not be on sale like this forever!

The biggest bargains in banking are abroad (but beware of the risks!)
The cheapest banks on a price-to-book value basis are overseas, and two in particular that caught my eye are Royal Bank of Scotland (NYSE: RBS  ) and Deutsche Bank AG (NYSE: DB  ) . These banks are excellent examples in my bargain-hunting, because one is a bargain, and one is cheap for a reason.

Royal Bank of Scotland appears especially cheap right now by most metrics. Shares are trading for just over half of book value, but, as the saying goes: "If it sounds too good to be true, it probably is." The main reason I'm shying away from investing in RBS is that the bank's restructuring is still in a very early phase, especially when compared with U.S. banks.

The bank has done a good job so far of cutting costs and downsizing its operations, but the economic conditions in the U.K. and Europe are a cause for concern. In addition, the U.K. government holds an 82% stake in RBS, meaning that the government has substantial say in what goes on at the bank. Generally, government control like this should be a red flag to outside investors.

Deutsche Bank, on the other hand, is a cheap bank that may indeed be worth a look. Shares are trading for around 66% of book value and 87% of tangible book value. In my view, Deutsche Bank is simply a much more solid operation than RBS.

Instead of the massive downsizing that we've seen from most of its competitors, Deutsche Bank has decided to diversify its operations by acquiring several smaller banks, increasing its exposure to retail banking and expanding its client base. The bank has also made it a priority to improve the performance of its investment banking division. The bank has healthier capital ratios than most of its peers and anticipates raising return on equity to 12% by next year, part of the company's strategic plan known as "Strategy 2015+."

Foolish final thoughts
Many banks are in the midst of a "turnaround" of some sort right now, and this is the main reason the sector is relatively cheap right now. The only difference between companies is how massive of a turnaround they need and how much further they still have to go. 

Companies like Royal Bank of Scotland are still in the very early stages of their turnarounds, which adds tremendous uncertainty for investors. I prefer to stick with companies like Citigroup and Deutsche, which have made excellent progress but still have a way to go -- which is why they still trade for a discount.

There may be some further price swings to come over the next couple of years as the companies' plans play out, but as Foolish investors, we're in it for the long haul. You may not be thrilled with the performance of these stocks six months from now, but I believe that six years from now, you'll be smiling from ear to ear for having bought in at these prices.

The biggest threat to the big banks
Do you hate your bank? If you're like most Americans, probably so. While that's not great news for consumers, it certainly creates opportunity for savvy investors. That's because there's a brand-new company that's revolutionizing banking and is poised to kill the traditional brick-and-mortar banking model. And amazingly, despite its rapid growth, this company is still flying under Wall Street's radar. For the name and details on this company, click here to access our new special free report.


Read/Post Comments (0) | Recommend This Article (0)

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.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2841280, ~/Articles/ArticleHandler.aspx, 12/21/2014 2:35:53 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement