Citigroup's Shares Will Fall on Thursday -- Investors Should Look at Them Now

The Fed nixes Citigroup's capital return plan, but that needn't concern long-term investors.

Mar 26, 2014 at 7:00PM
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U.S. stocks could not sustain the morning's gains on Wednesday, as the benchmark S&P 500 ended the session with an 0.7% loss. The narrower Dow Jones Industrial Average (DJINDICES:^DJI) fell 0.6%. Shares of Citigroup (NYSE:C) managed to outperform the broad market today, but that won't be the case tomorrow, as the Federal Reserve announced after the market close that it has rejected the bank's capital return program, along with that of four other institutions (three subsidiaries of foreign banks and Zions Bancorporation). Shares of Citigroup fell 5.2% in after-hours trading, but while traders may be selling the stock, it's providing an opportunity for patient investors to take a closer look at them.

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The rejection of Citigroup's capital return program did come as a bit of nasty surprise to the market, as the Fed announced last week that it had passed its annual "stress test," which looks at major banks' capital adequacy under adverse economic scenarios (this was not the case of Zions -- the only institution among the 30 being examined that failed to meet the Fed's requirements.)

If you're a trader, perhaps this is sufficient reason to sell the shares, but for a long-term, fundamentally oriented investor, I don't think it does much to alter the reasons for owning the stock. The likely outcome is that the dividend increase and share repurchases that investors were expecting this year will be approved a year from now. Is the difference worth a 5% haircut in the stock's value? Perhaps, but that looks like an upper bound -- combine a "normal" bank dividend and buyback yield, and you might just about get to 5%.

(Naturally, there may be other considerations; for example: Is Citigroup's common equity riskier than investors had thought before the Fed's announcement? My reply to that objection is that last week's result -- a pass on capital adequacy -- is more relevant in that regard.)

Besides, as of today's closing prices -- that is, before any price decline that may occur on Thursday -- Citi's shares already look reasonably compelling, trading at a 9% discount to their tangible book value and just 10.4 times next twelve months' earnings-per-share estimate. The latter multiple represents roughly a one-third discount to the S&P 500's forward earnings multiple, which stands at 16. Whether or not Citi's shares are significantly undervalued on an absolute basis (i.e., relative to their intrinsic value) may be a matter of legitimate debate (I happen to think they are), but that they represent better value than the broad market looks incontrovertible. In a market that looks a bit overheated, with fewer and fewer clear values, that alone makes Citigroup's shares worth a second look.

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Alex Dumortier, CFA, has no position in any stocks mentioned. The Motley Fool owns shares of Citigroup. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.

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