Citigroup looks undervalued, but too risky to enter here
I did a deep valuation analysis on Citigroup today, digging into their earnings reports for the last three years as well as analyst estimates for the next 4 quarters. Here are my conclusions.
In forward P/S terms, Citigroup is nearly the cheapest it has been in the last three years. However, in forward P/E terms, it's nearly the most expensive it has been in the last three years. The valuation in P/S terms may be more important, because analysts expect the earnings numbers to climb steeply back up to meet the sales numbers within a few years. (Roughly 23% earnings growth rate expected in the next 4 quarters, and nearly 4% growth rate for sales.)
However, there are risks. Analysts are predicting a steep drop-off in sales next quarter due to the pandemic's impact on consumer credit, which is sharply down. Then they expect sales to recover from there. However, an alternative scenario is that the pandemic is prolonged and we don't get a vaccine this fall, in which case credit might continue to deteriorate and Citigroup's sales might fall off even more steeply in Q4 than in Q3.
I'm also worried about the outlook for the mortgage market. Current housing prices are artificially high, but there's a reckoning coming for residential real estate whenever Congress allows mortgage forbearance to expire. (Expiry is scheduled for August 31, but there's talk of extending it to next year.) If forbearance is extended, then renters and borrowers may not pay, which would hurt bank earnings. If forbearance is allowed to expire, then housing prices will fall and mortgage sales numbers will fall with them. Banks would seem to be in trouble either way, and I'm not certain analysts have accounted for this.
Thus, I will not be entering Citigroup here. I expect the narrative around banks to remain negative for the next quarter as bankruptcy and default rates continue to rise and credit continues to deteriorate. There's a good chance we will retest the bottom near 36/share sometime in the coming quarter; if so then I will revisit the numbers on Citigroup and consider an entry there.
(P.S. It's also worth pointing out that under normal market conditions, Citi's sales and earnings appear to grow linearly in dollar terms, which means that growth decelerates over time in percentage terms. In other words, Citigroup is not a compounder. That's reason enough to only trade this stock, not buy-and-hold for the long term.)
In forward P/S terms, Citigroup is nearly the cheapest it has been in the last three years. However, in forward P/E terms, it's nearly the most expensive it has been in the last three years. The valuation in P/S terms may be more important, because analysts expect the earnings numbers to climb steeply back up to meet the sales numbers within a few years. (Roughly 23% earnings growth rate expected in the next 4 quarters, and nearly 4% growth rate for sales.)
However, there are risks. Analysts are predicting a steep drop-off in sales next quarter due to the pandemic's impact on consumer credit, which is sharply down. Then they expect sales to recover from there. However, an alternative scenario is that the pandemic is prolonged and we don't get a vaccine this fall, in which case credit might continue to deteriorate and Citigroup's sales might fall off even more steeply in Q4 than in Q3.
I'm also worried about the outlook for the mortgage market. Current housing prices are artificially high, but there's a reckoning coming for residential real estate whenever Congress allows mortgage forbearance to expire. (Expiry is scheduled for August 31, but there's talk of extending it to next year.) If forbearance is extended, then renters and borrowers may not pay, which would hurt bank earnings. If forbearance is allowed to expire, then housing prices will fall and mortgage sales numbers will fall with them. Banks would seem to be in trouble either way, and I'm not certain analysts have accounted for this.
Thus, I will not be entering Citigroup here. I expect the narrative around banks to remain negative for the next quarter as bankruptcy and default rates continue to rise and credit continues to deteriorate. There's a good chance we will retest the bottom near 36/share sometime in the coming quarter; if so then I will revisit the numbers on Citigroup and consider an entry there.
(P.S. It's also worth pointing out that under normal market conditions, Citi's sales and earnings appear to grow linearly in dollar terms, which means that growth decelerates over time in percentage terms. In other words, Citigroup is not a compounder. That's reason enough to only trade this stock, not buy-and-hold for the long term.)
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