It's time for my quarterly-ish buys in the financials-centric real-money portfolio I manage for The Motley Fool.
Let's start with a company I'm buying for the fourth time: Citigroup (NYSE: C).
As the market and bank stocks have risen, it's gotten harder to find great values. Yet I think Citigroup is still in good-value territory. Of the American megabanks (JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley). In the American megabank category, Citigroup is the only one trading below tangible book value (0.9 times tangible book).
Given the amount of pessimism built in, I was bullish on the prospects of Citigroup's turnaround under former CEO Vikram Pandit. I'm even more bullish now that it's being led by CEO Michael Corbat and Chairman Michael O'Neill (who led the turnaround of Bank of Hawaii, also a pick in my real-money portfolio). My fellow Fool Matt Koppenheffer did a good job of laying this out when he bought shares for his own real-money portfolio.
Now, "too big to fail" doesn't mean "too big to have poor shareholder returns," but in addition to its low valuation and its promising management, consider these two additional factors about Citigroup:
- Even with a paltry return on equity of 6.5%, Citigroup's is at a reasonable 12.8 price-to-earnings multiple. For perspective, 10% is generally a pretty good return on equity and best-in-class bank Wells Fargo's 13.4% is just over double Citigroup's. Citi isn't in Wells Fargo's class, but you get an idea of the room Citigroup's turnaround has to drive improved profitability.
- Citigroup is still paying out a regulator-restricted quarterly dividend of a penny. As part of 2013's stress test, Citi was deemed fit enough by the Fed to announce a $1.2 billion stock buyback program -- a good strategy when shares are trading at these depressed levels. Meanwhile, whether it's 2014 or later, future dividend increases should be a catalyst for Citigroup shares.
My next buy is a new company to my portfolio: IBM (IBM 0.78%). While IBM does make some money by financing its clients' purchases, this tech juggernaut is decidedly a nonfinancial company.
Outside of the financials sector, I keep a wish list of about 30 companies that I've deemed either high quality or high potential. My hope with these companies is that something the market deems as "bad" will happen to give me a good entry point.
In IBM's case, there are worries about its growth prospects. While buybacks have helped boost its five-year earnings-per-share growth rate into the double digits, its top line has grown by an anemic 1% a year. This is despite capital expenditures that are more than keeping up with depreciation and goodly sums spent on acquisitions.
That said, I gained respect for IBM when I was an employee at one of its primary competitors, Accenture. Based on size and prestige, IBM and Accenture are the two premier tech-focused consulting firms in the world.
I remember being at Accenture in 2002, when IBM doubled its consulting workforce by acquiring PricewaterhouseCoopers' then-consulting arm, PwC Consulting. Since that key move, the services part of IBM's business (in other words, consulting and outsourcing versus hardware or software) has continued to grow and is currently roughly half of IBM's business:
|
|
Sales |
Before-Tax Profits |
|---|---|---|
|
Services (i.e., Consulting and Outsourcing) |
56% |
45% |
|
Software |
27% |
49% |
|
Hardware |
17% |
6% |
Source: IBM's 2012 10-K; excludes the Global Financing and Corporate and Other areas.
Note in the table that although software's massive margins still make it the primary profit driver (barely) over services, IBM's well-known hardware business isn't as consequential.
Of course, it's not quite so discrete -- all three parts (hardware, software, and services) overlap and work together in a complementary fashion. Still, the larger a part that IBM's consulting/outsourcing business plays, the more confident I am personally in being able to judge its prospects. Why? Because no matter what the megatrend or flavor of the day is (be it big data, the cloud, social networking, or outsourcing), I'm confident the consultants at both Accenture and IBM will adapt to chase the dollars.
So, why IBM right now instead of Accenture? Accenture, after all, is a pure play on consulting and outsourcing. The answer, in a word, is price. When I look at their five-year multiples on earnings, I see IBM sitting at just 12.4, versus 20.1 for Accenture.
Looking at other metrics around IBM, I see a 23.9% return on capital and a 77.4% return on equity that are both indicative of an asset-light venture. I also see gross margins of 48.7% and net margins of 15.9% -- both quite impressive.
Finally, I'd be remiss if I didn't point out that at current prices, IBM's trading in the neighborhood of Warren Buffett's average price as he's been buying up shares since 2011. Especially given the rising market, that's not a bad reference point to consider.
My final buy is back in my banking wheelhouse: Capital One (COF +1.26%).
Similar to the average investor overestimating the size of IBM's hardware division, many folks overestimate Capital One's reliance on credit cards. To be sure, credit cards are around 40% of Capital One's business (that's either as a percentage of loans or as a percentage of profits). What makes up the other 60% of Capital One's loan portfolio? Home loans, auto loans, business loans, and business-oriented real-estate loans.
Due to savvy bank acquisitions, it's now supporting these loans largely with a stable deposit base (as opposed to riskier debt). One of these acquisitions was the American portion of ING Direct in 2012. The rebranded Capital One 360 (Capital One's previous Internet banking operations plus ING Direct's) is arguably the most formidable player in the growing online-banking space.
In addition to a healthy credit-card business and an interesting growth opportunity in online banking, Capital One boasts a visionary leader in Co-Founder/Chairman/CEO Richard Fairbank, a history and culture of innovation, scale (it's the sixth largest U.S. bank by deposits), and a strong track record.
The credit-card side of the business can be quite sensitive in a downturn, and Capital One's historic reliance on acquisitions could backfire at some point, but at 1.6 times tangible book value and about 10 times earnings, I think we're getting a reasonable price for a company whose potential benefits outweigh its potential risks.
After waiting a full trading day (per Fool guidelines), I'll be buying shares of Citigroup, IBM, and Capital One in my real-money portfolio. Click here to see the rest of my portfolio and follow along.
