Summary
- BOA clearly generates stronger risk-adjusted returns compared to Citi. It is a superior banking franchise, no doubt.
- Citi's cheap valuation, however, is too tempting for some and yet many fear it is a value trap that will perennially underperform.
- This article looks at a detailed relative valuation.
- Are you a Citi or BOA fan?
- After my research, I ended up adding more in one of these names.
One of the most common questions investors ask me is which large bank to buy. JP Morgan (JPM) has always been my default and "safe" response but immediately noting that you also pay for quality.
Bank of America (BAC) and Citigroup (C), on the other hand, present their own enticing opportunity at times and for seemingly better value.
(source)
In this article, I will compare and contrast Citi and BOA and conclude, with reason, which is the better bank to buy at this point in the cycle.
I will consider several aspects including:
- The attractiveness of the business model;
- Profitability and returns on capital;
- Risks and cost of capital;
- The quality of management; and
- Strategic direction.
All data and charts are sourced from Citi's and BOA's investor relation sections.
A few words on the valuation of banks
Banks are not like other corporates.
They are best valued on the basis of returns on tangible book value. Generally speaking, where a bank earns its cost of capital, it should trade at tangible book value. Banks in developed markets typically have a cost of capital of ~10 percent. Thus a bank that is expected to consistently earn a 10 percent return on capital, should trade at 1.0x book. JP Morgan for example often delivers a high-teens return on tangible common equity and as such, is rewarded with a 2.0x or higher price to tangible book value.
