Despite the markets making new highs on a daily basis lately, the banking sector is still relatively cheap. Some banks, like Citigroup (NYSE:C) are cheap simply because they trade for a steep discount to their intrinsic and long-term value. Others, like BofI Holding (NYSE:AX) are cheap because of their tremendous growth potential.
Let's take a closer look at these two companies and decide which one is the best fit for your portfolio.
Citigroup is in better shape than you may think
By far the cheapest of the "big four" U.S. banks, Citigroup trades for just 74% of its book value, and 87% of its tangible book value, which represents all of the bank's tangible (and therefore sellable) assets.
In other words, if Citigroup were to decide to go out of business tomorrow and sell off all of the assets on its balance sheet, the amount of money they receive should be substantially more than shares are worth. That is cheap.
Most of Citigroup's business is actually doing quite well. The bank is better capitalized than some of its more highly valued peers, with a Basel III Tier 1 Common Ratio, a good indicator of strength, of 10.6%. In contrast, Bank of America and JPMorgan Chase's ratios are 10% and 9.5%, respectively. Citigroup's capitalization is also improving more rapidly than the others, with 8% year-over-year growth compared with 5.5% for JPMorgan and just 3.4% for B of A.
However, Citigroup is still cheap for a couple of reasons. First, it has a lot of international exposure, particularly in emerging markets, and it is very tough to quantify the potential effects of a global downturn on Citi's global business.
Also, and the easier reason to keep track of, is that even though Citigroup has done an excellent job of winding down its Citi Holdings "legacy" assets so far, there is still a long way to go. The unwanted assets have been reduced from $290 billion in 2011 to just $114 billion currently, but considering how Citigroup's market cap is about $147 billion, the bad assets could do some damage to the stock price if a large percentage were to default or lose significant value.
Despite this, I feel the risk is more than priced in, and Citigroup's valuation will continue to climb as more and more of the bad assets are expunged from the company's balance sheet.
BofI could be at the forefront of something revolutionary
BofI Holding is not cheap in the same sense as Citigroup is.
In fact, when you look at a chart comparing the two companies' valuations, it looks downright expensive. Citigroup trades for less than the value of its tangible assets, while BofI trades for more than 3.5 times its tangible book value.
The reason BofI is cheap is because it is one of the most innovative companies in the banking sector, if not the entire market, and its potential remains largely untapped.
In a nutshell, BofI's (which stands for Bank of Internet) business model is to keep their costs as low as possible by doing its business almost exclusively through the Internet. In fact, despite having over $3.8 billion in assets, the company operates from a single office in California.
As a result, BofI operated at a TTM net profit margin of almost 34%, as compared with 25% for the overall banking industry. The company's revenue is growing at twice the industry average, and the consensus of analysts covering the company calls for BofI to grow its earnings at an average annual rate of 29% for the next three years.
In addition to keeping its expenses down, BofI can also pass some of its savings along to customers, which gives it a unique competitive advantage. If the bank doesn't have to pay for physical locations, and has a fraction of the employees of similarly sized banks, it can afford to offer mortgage and other loan products at lower interest rates than the competition and can pay more than peers on deposit accounts.
So, which to buy?
There are very valid, but different reasons to buy each of these banks and both make perfect sense for a long-term growth portfolio.
Citigroup's business is already there and doesn't have too much room to grow (relatively), but you can buy it for less than it's worth. So, you can buy a company worth $54.51 per share for just over $48, and any future growth is simply a bonus.
BofI, despite all of its recent growth, is still a very small company in banking terms. With $3.8 billion in assets, it pales in comparison to the big banks like Citigroup, which has nearly $2 trillion in assets. So, the growth potential here is huge.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends BofI Holding. The Motley Fool owns shares of BofI Holding and Citigroup. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.