Changing My Banking Stock Portfolio
Federico is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Several weeks ago I talked about how Bank of America (NYSE: BAC) was my favorite banking stock to play America's recovery. Since then, its share price went up strongly from $9.60 to around $10.50 (+9%). What should an investor do if you hold BAC in your portfolio? What I would recommend is selling 50% of your position at BAC and investing the proceedings in my second banking choice: Citigroup (NYSE: C). Let's review my case for such a recommendation and take a look at current valuations.
BAC, which is up by 88% Year to Date (YTD), is now trading at 2013 x9.1 P/E and 75% price to tangible book value. It is a great stock with great management. Obviously, its strategy has been perceived as the right one by the market, given its out-performance of the US banking sector index (which is up by 21% YTD).
As we said before, BAC is focused on increasing its Tier 1 capital ratio (today at 8.97%, improved by 102 bps quarter over quarter) and normalizing all its business lines: credit quality is getting better, mortgage banking is doing better than expected, and most settlement costs have been absorbed. Even if all of the above is true, there is a price for everything, and taking some profits may protect your portfolio. Before thinking of BAC I thought Wells Fargo (NYSE: WFC) was the game to play, but its tremendous operational out-performance was, at some point, fully recognized by the market.
As a matter of fact, if you had invested $10 five years ago in WFC ,you would still own $10; but if you invested those $10 in BAC, you would only be left with $2. Following with the same logic, if five years ago you had invested your $10 in C now you would only have $1. Maybe now, given recent developments, the time to own some Citi shares has finally arrived.
Citi, which is up by 38.6% YTD, is now trading at 2013 x 7.2 P/E and 65% price to tangible book value. But that's not the main reason to own its shares. Many things are changing at the bank. Not only has the CEO changed from Pandit to Korbat; Citi is also sharpening its recovery strategy and repositioning actions across its business lines to reduce expenses. As an example, today Citi announced that it plans to eliminate 11,000 positions (according to analysts this should benefit 2014 EPS by 3%).
Even if the strategic direction appears unchanged from Padit's era, there will be further rationalization of current expense levels and resource allocation. The winding down of Citi Holdings (CH) will surely be accelerated (holdings at CH are down $94 billion YoY), and management is targeting a mid term Return On Tangible Equity (ROTE) above 10%. I am sure that now is the time when the bank will start surprising on the upside, and I expect a ROTE above double digits for next year and a ROE at around 7.8%. I do not think all these factors are already priced in.
Given BAC's fast out performance over the sector, it could be a good idea to trade a part of the portfolio towards Citigroup. This would be a way to invest in Citi while taking some profits at BAC without increasing your exposure to the banking sector. Even if I still strongly believe in BAC's recovery going forward, diversifying the portfolio after a sharp price increase is not a bad idea. The US economy has a lot of room to ameliorate, and banks are one smart way to benefit from such recovery. This is just a suggestion on how to trade around that thesis, but not the only one. As many of you may know, I am a fixed income investor and you may find some good bond trading ideas on Citi and BAC at Warrentrades.
martinzaldua has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America, Citigroup Inc , and Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!