Citigroup — free report for Ask Matt, Dangerous Rating

Here is our free report on Citi.

See my recent post Mayo Is Right about Citi for details on our analysis of the company’s loose Deferred Tax accounting and other Red Flags. There are other reasons (besides questionable accounting for deferred tax assets) to run from this stock.

RED FLAGS:

  1. Over $7bn in off-balance sheet debt
  2. $2.2bn in under-funded Pension liabilities
  3. Over $10bn in Asset write-offs
  4. Very Dangerous valuation (detail follow)

Our discounted cash flows analysis reveals another RED FLAG — a Very Dangerous Valuation. At $3.67, Citi’s stock price implies the company will grow its NOPAT (Net Operating Profits After Tax) by over 15% per year for each of the next 25 years. In other words, to justify the current valuation of its stock, Citi has to grow its NOPAT by 15% com pounded annually for 25 years. As explained in , Citi’s performance must meaning fully exceed the current expectations of a 15% CAGR for NOPAT over 25 years in order for (long) investors to make money in the stock.

All the details are in our free report on Citi. For the asset write-offs and their impact on economic earnings see Appendix 3 in our report. Our Risk/Reward rat ing is on page 1.

See Appendix 4 to learn how  we calculate NOPAT and NOPAT Margin. See Appendix 5 for details on how JDSU’s Invested Capital is bloated due to the asset write-offs and the large deferred tax asset. Appendix 7 (in the Return on Invested Capital sec tion) shows how a rising NOPAT Margin and rising Invested Capital Turns result in a jump in ROIC (to .6%) and negative Economic Profit of -$41.2bn while Net Income is nega­tive $9.2bn — during the last fiscal year.

As per  and , C fits the profile of a good stock to sell.

**See  and Economic Versus Accounting Profits for more details on why account ing prof its are not reli able indi ca tors of cor po rate prof itabil ity or value creation.

2 Comments

  • Herb

    September 3, 2010

    I don’t think you consider the vast franchise reach of this financial institution, which is second to none in terms of number of branches and country presence worldwide. There isn’t another bank which comes even close. I believe the 15% NOPAT addressed in your analysis will be surpassed once the financial crisis is behind us. This may take a couple of years but we will see it.

  • David Trainer

    September 7, 2010

    Herb:
    Thank you for your comment.
    My point about the valuation of the stock is that 15% CAGR in NOPAT for 20 years is the current level of expectations in the stock price. For investors to make money in Citi shares, the company will have to produce substantially more profits that what already embedded in the stock. Even if the franchise value is as good as you suggest, the stock market seems to have already taken that into account and priced the stock accordingly. Given the RED FLAGS (including the already-high expectations), the stock has more downside risk than upside potential. I prefer to buy stocks with low expectations and sell them when expectations get high, like the expectations in Citi’s price.

    See this blog post for more info on the “Buy low expectations and sell high expectations” investment strategy.

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