A value stock is only worth buying if it's, well, a good value. A beaten-down share price alone doesn't make it a bargain -- it has to be underpriced because of temporary factors but really worth considerably more. Over time, once those temporary factors (like, say, a pandemic) get sorted out, the market will recognize its intrinsic value, rewarding investors who bought when it was down.
That's a value stock. A value trap is a stock that may look like a value based on its price, but is not because there are underlying issues or longer-term concerns that indicate the stock won't bounce back and will likely stay flat or lose value.
With that in mind, let's take a look at Citizens Financial Group (CFG 1.22%), the parent company of Citizens Bank, the 16th-largest bank in the country, with $179.9 billion in assets as of June 30. Is it a value or value trap?
What do the key indicators say?
There are several key indicators of a value stock, particularly among banks. One is the price-to-book ratio, which is calculated by dividing a company's stock price by its book value per share. Book value is total assets minus any liabilities, which gives a better representation of a bank's intrinsic value.
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As of Tuesday's close, Citizens Financial had a stock price around $27 per share, which is down about 34% from where it started the year. Like all banks, Citizens has been severely impacted by the economic downturn, particularly through a high provision for loan losses due to pandemic-related economic hardships. Citizens allocated $464 million for potential losses in the second quarter, up from just $97 million in the second quarter of 2019. That allowance tanked the bank's earnings, dropping net income 44% year over year to $253 million.
Otherwise, the bank had an excellent quarter, beating earnings estimates with record revenue, up 6% to $1.75 billion. Net interest income was flat at $1.16 billion -- which, in a 0% interest rate environment, is not bad. Net interest income was buoyed by an 8% increase in loans to $125 billion, including $4.7 billion in Paycheck Protection Program (PPP) loans. But even without the PPP loans, loan growth was up. Also, non-interest revenue jumped 28% to $590 million, thanks to a record quarter in the mortgage banking business. Also, total deposits were up $19.6 billion, or 16%, to $143 billion.
Citizens' book value as of Aug. 7 was around $47 per share, up from June 30, when it was $32.13 per share. So while the stock price is down, the book value is rising. As a result, Citizens' price-to-book ratio at Tuesday's prices was a low 0.57. For perspective, a price-to-book ratio of 1.0 typically means the stock price and book value per share are aligned.
It's also important to examine the return on equity (ROE), which is determined by dividing net income by shareholders' equity, or net assets. It is a measure of how efficiently the company uses its assets to generate profits. Citizens' ROE as of Aug. 7 was about 5.3%, higher than the industry average of 3.5% in the second quarter.
A good value
Another metric to look at is price-to-earnings ratio, which measures a company's stock price against its earnings per share. Citizens' P/E for the trailing 12 months is about 10.6, which is relatively low and indicates it may be undervalued. The forward P/E, which is based on projected earnings over the next 12 months, is much higher at about 22, indicating the market expects to see growth. Indeed, analysts predict earnings growth for Citizens over the next few years.
Also, with an increase in deposits, Citizens has a good loan-to-deposit ratio of 87.5%, which means it has ample liquidity for loans and more reserve builds if necessary.
Considering all of these factors, Citizens looks like a good value -- not a value trap. The bank has solid liquidity and has exhibited strong revenue growth. As the economy improves and the provision for credit losses comes down, earnings should grow.
