Roundtable: Sell This Bank

Recently, we answered the question, "If I had to buy a big bank ..."

Morgan Housel went for JPMorgan Chase (NYSE:JPM), Alex Dumortier went for Bank of America (NYSE:BAC), and Matt Koppenheffer went for Goldman Sachs (NYSE:GS). Read their rationale and qualifications here.

Now, we'll tackle the ugly flip side: Which banks are sells.

The choices are the same as with the buys:

Which big bank is a "sell" at today's prices?

Morgan Housel: I'll be thoroughly dull and single out Citigroup. Yeah, it's everyone's favorite bank to kick in the shins, but for good reason. Let's count the ways:

• Recent news that one of its most profitable assets -- Banamex -- might have to be dumped thanks to Mexico's state-run banking regulations highlights the painful reality of being 34% owned by the government. Name one company that's rewarded shareholders long term while being largely state-owned. Stumped? That's reason enough to sell Citigroup.

• It still can't earn a profit. Or at least a legitimate profit. When interest rates are zero and you're tripping over losses, it's probably time to look for new work.

• More specifically, where future profit will come from is still a big, fat, black hole. One-third of its balance is quarantined in a segment called Citi Holdings. Management's currently "rationalizing" Citi Holdings, which is just a polite way of saying they're trying to liquidate a few hundred billion dollars of assets that only worked when the economy ran on Red Bull and leverage. The future Citigroup will look nothing like the old Citigroup.

• It's got a $100 billion market cap. Someone, somewhere, is expecting big things from this company. Sadly, I think they'll be disappointed.                         

Alex Dumortier: In the "Buy This Bank" roundtable, I took a long-term view of the issue. When it comes to selling, I thought I'd adopt a shorter timeframe (say, three to 12 months). On that basis, I think any and all of these banks are a potential "sell" in this environment. In fact, I think an interesting short-term trading strategy (for very advanced investors) might be to sell short the whole group, hedged with a long position in the broader banking sector or the S&P 500.

The megacap banks have led the way during this year's market rally. On a float-weighted basis, this group of eight stocks (BofA, Citi, Goldman, JPMorgan, Morgan Stanley, PNC, US Bancorp, and Wells Fargo) has returned 195% from the March 9 market low, well ahead of the KBW Bank Index (+141%) or the S&P 500 (+61%). On a weighted basis, the group now trades a 39% premium to book value; meanwhile, its return on equity over the last 12 months is a piddling 4.7%.

In my review of Wells Fargo earnings on Wednesday, I wrote: "As investors come to terms with the ongoing costs of the banking crisis, [bank] valuations will come under greater scrutiny. As a result, I expect greater price volatility -- of the downward variety, that is -- over the next 12 months."

Apparently, I'm not the only one who thinks the prospects for banks are misunderstood. In a piece published yesterday in the Financial Times, Mohamed El-Erian, the CEO of bond giant PIMCO, wrote: "... It is clear that the banking system will soon be taking an important step toward the "utility" end of the institutional spectrum – a likelihood that is yet to be internalised, both in market valuations and ..."

The banks that are the most vulnerable to a short-term revaluation are, to my mind, those that have risen the fastest and sport the weakest fundamentals: Bank of America (+341%) and Citigroup (+325%).

Matt Koppenheffer: JPMorgan Chase has gotten a lot of press throughout the financial crisis as one of the best-run banks and a safe haven for investors. And if you ask me, the stock trades today as if the bank's management team walks on water. Maybe JPMorgan is just that good, but consider me unconvinced.

The most recent earnings report from JP showed results that were driven almost entirely by investment banking and proprietary trading. Meanwhile, the company's core banking operations looked green around the gills -- to say the least.

Right now the stock is trading at nearly 14 times 2010 earnings, which are going to be dependent on corralling that banking division back into solid profitability while keeping the party going in the i-banking halls. This ain't no Goldman Sachs, people, and I think investors should be demanding more of a margin of safety than JP's current stock price is offering.

All the picks
With the qualification that these are "if I had to" picks, our two banking roundtables summarize like this:

There you have it. Three analysts. Three buys. Three sells. What are your thoughts? Share them in the comments section below.