Thursday, November 15, 2007

Why some financials are attractive now


Take Citibank. Can we guess how low "low" is?

Without double-checking the data, here's a quick calculation:

It's worth $25/share, based on it's "book value".

There are about 5 billion shares issued.

Suppose they take even $15 billion more in write-downs (20% of a $70 billion exposure, say). That would be $3 per share, which would bring "book value" down to $22/share. Bear in mind also that they have already done about $10 billion ... (I don't know if that is in the $25/share figure, however).

If you don't believe that their business is changing dramatically because of all this, you can slap a 1.5 multiple on that, which isn't too aggressive for a big bank. That would equate to a $33/share stock.

Last year, the company made over $5 billion a quarter.

Even if they used all of that to pay for write-downs, handled a significant growth slowdown (trim even up to 25% of earnings or $5 billion), and covered the dividend (just under $10 billion per annum), it would seem they have earnings power to avoid going into massive negative quarters, while you hold their stock.

You end up with a flat-ish stock, based around $33/share that pays a whopping 6% in dividends, at current prices (about $34.-$35). At the end of that period, valuation could go up to old levels, giving a huge gain.

This may be why superior, value folks, like Bill Miller, are interested in the long-term potential of the major bank stocks.

The risks are that they have other big problems develop. Maybe some charge-offs in the credit-card business, in buyout-loans, or plain mortgaged-backed bonds. They also appear to be paying a price already in the borrowing markets, but that will just pinch their slightly and slowly earnings, which we've already accounted for, and could easily reverse with proper attention.

[BE SURE to do your own calculations, checks, and make your own decisions about what to own or not ... If you don't, just got to, say, and just-do-it.]

Update: The bulk of the charges are not in the $25/share figure, as of this press release. The other important consideration is that these charges should be considered after-tax. Therefore, the net change is not much: subtract $7B for the charges already announced and add $5.5B for tax considerations, for a net of $1.5B, or about $0.31/share, which, in turns, lowers the $33 figure to $32.50, which is a point statistic, but probably near a lower bound.

Here's a quick summary:

7 Billion after-tax announced
9.5 Billion after-tax to go ($15 Billion pre-tax)
10 Billion in dividend payment for 2008
26.5 Billion needed
15 Billion in net earnings for 2008, assuming 25% slowdown
10.5 Billion hit to equity or about $2/share

$23/shr approx equal to $33 stock price, conservative calculation (but not super pessimistic).

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