Value stocks have long been overshadowed and outperformed by growth stocks, but they should have their day in 2022. The primary reason is that the two prevailing factors in the economy right now -- inflation and rising interest rates -- generally favor value stocks.
Value stocks are typically those of more established companies that are better able to raise their prices in times of inflation as demand for their products -- think food and energy -- remain high. Growth stocks are typically valued based on expected growth, so they may not have the earnings in the present to increase margins during inflation.
The financial sector is also a good place to look right now as inflation leads to higher interest rates, which generally benefit banks and other businesses that rely on interest income. Here are two value stocks in the financial sector that struggled in 2021 but are poised to rebound in 2022.
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Citigroup: Transformation in progress
Citigroup (C 0.26%) is one of the big four national banks, so one would think it had a good year in 2021, considering it was a big bounce-back year for most banks after a disastrous 2020. But it wasn't, as Citigroup badly lagged behind its competitors. The KBW Nasdaq Bank Index was up about 35% in 2021, while Citigroup was down 1.9% for the year.
The decline was largely due to the fact that Citigroup was in a transition year in 2021. New Chief Executive Officer Jane Fraser took over a company that had issues with its internal controls and risk management, as the bank was fined $400 million by the Office of the Comptroller of the Currency for unsafe and unsound practices. Perhaps the most egregious example was $900 million sent to the wrong customers in 2020.
As a result, the bank invested $1 billion in updating its systems and improving its internal controls. Also, Fraser made some major moves to refocus its strategy, selling some of its international properties in underperforming markets and investing in other areas, like wealth management. However, the changes led to an increase in expenses. For example, the sale of its Australia consumer banking division resulted in a $680 million pretax loss.
But the changes and investments Citigroup made in 2021 set it up for success in 2022 and beyond. The stock is already up about 7% year to date, while the KBW Nasdaq Bank Index is up about 2% in the same period. So far this year, Citigroup is outperforming the two largest banks, JPMorgan Chase and Bank of America. Yet its valuation remains ridiculously low, with a price-to-earnings (P/E) ratio of about 6 and a price/earnings-to-growth (PEG) ratio of 0.73. These metrics indicate a stock that is substantially undervalued compared to its earnings potential. And it is trading below book value, with a price-to-book (P/B) ratio of 0.70. That means its stock price is below the value of its assets. This is a stock with room to run.
As for growth drivers, Citigroup will benefit from the expected above-average growth in gross domestic product as well as the probability that the Federal Reserve will raise interest rates several times this year. The combination should result in more lending and higher interest income. Furthermore, the bank plans to resume share repurchases, which should help boost its share price.
The transformation under Fraser should start to result in greater operational efficiencies and a more streamlined focus on the companyʻs strengths, leading to earnings growth over time.
Rocket Companies: Gaining market share
Rocket Companies (RKT 1.32%) has been a bit of a puzzle to investors since it went public in August 2020 at about $18 per share. The market leader in home mortgages had a record year in 2020 with $320 billion in loan originations. In addition, it had record revenue and net income in 2020, but the stock price barely budged.
In 2021, revenue and earnings were down through the first three quarters, but that was compared to a record 2020. Yet, the company still beat analysts' estimates in the third quarter and is on pace to top 2020's record in loan originations, CEO Jay Farner said on the Q3 earnings call. But the stock price tanked, down about 27% in 2021. The slide has continued in 2022, and it was down about 10% as of Jan. 31 and is trading at around $13 per share.
The market has undervalued this stock, which has a trailing 12-month P/E ratio of about 4. But the company has managed to increase its market share in an otherwise difficult year for mortgage companies to 9.5% from 8.5% in 2020. It expects to expand that to 10% in 2022, and has a 56% operating margin and a stellar 74% return on equity.
The company has made some recent moves that should propel its stock price in 2022 and beyond. Late last year, it formed a partnership with Salesforce to launch a mortgage-as-a-service offering to banks and credit unions through Salesforce's Financial Service Cloud. The company can use Rocket's technology, brand, and platform to offer mortgages. This will be particularly helpful for small and mid-sized banks that don't have the resources to run their own operations. Farner sees this as an opportunity to expand Rocket's market and increase its share.
Overall, while rising rates could slow things down in the housing market, that could bring down or stabilize home prices. And if inflation sends rents higher, that could be a plus for home sales.
While neither one of these stocks might soar in 2022, both should have nice rebounds from a subpar 2021.
