Citigroup: the 1-for-10 reverse split

Some Citigroup shareholders woke up this morning to a surprise; they found that the price of their stock had jumped from around $4.50 to $44.00!

Unfortunately, today’s price jump was not an overnight stock rush, but merely a 1-for-10 reverse split. That is, if you owned 10 shares of Citigroup on Friday with earnings of $0.31 per share, you now own 1 share of Citigroup with $3.10 of earnings per share. In other words, aside from the price, there is no material change in your ownership. Why would Citigroup do this?

CNBC suggested on its website that the reverse split was done to “improve investor’s opinion” of the stock. Other blogs have suggested that doing a 1-for-10 reverse split is a way to “trick” or “fool” investors into thinking they are buying a better company.

Pardon me for saying, but if you think that a $40 stock is “better” than a $4 stock, or a $100 per share company is “better” than a $50 per share company, you need to stop buying stocks until you know what you are doing.

In fact, there are several good reasons for doing a 1-for-10 split, none of which are listed above.

The first reason is to counter day trading. When a stock has a low price but trades with high volume (like Citigroup), it becomes a favorite with day traders. For a low priced stock, a change of a few cents means a few percentage points, and so such trades can be profitable for a day trader. Unfortunately, day traders do not add value to a company the way that long-term shareholders do. Increasing the share price helps keep day traders out and, according to Citi CEO Vikram Pandit, therefore reduces volatility. In the very short-term, the exit of day traders will likely cause a drop in Citi’s stock price.

The second reason is to bring in potential institutional buyers, such as mutual funds. Many mutual funds are not allowed to purchase a stock that is priced below a certain threshold, usually $5 or $10. At $4.50, many mutual funds are simply not allowed to buy shares, no matter how good the company might be as an investment. Although a 1-for-10 reverse split doesn’t really change anything except the price, more mutual fund managers will now be able to buy Citi shares.

The third reason is to allow pension funds to buy the shares. Just as many mutual funds are not allowed to buy stock worth less than $5 per share, many pension funds are not allowed to buy a stock that does not pay a dividend. With 29 billion shares outstanding previously, Citigroup would have found it difficult to pay even a token $0.01 dividend per share. As of today, there are 1/10th as many shares, and so Citigroup can once again introduce a dividend. Once this dividend is in place, more pension funds will be allowed to buy.

Aside from growing revenue and earnings, part of any good company’s strategy is to manage their stock. Institutional investors and pension funds add stability, since they tend to hold for weeks or months rather than just hours. And, if many institutional investors buy and hold, this limits the availability of the stock, driving up prices.

Today’s 10-for-1 reverse split was an immaterial - yet smart - long-term move for Citigroup.

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"You never want to think the best things are in the past. You want to get yourself to believe that the best things are going to be in the future."

Sandy Weill, former CEO of Citigroup


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US Banks to Rumble

I’ve been recommending US bank stocks for over a year now – after all, they are powerhouses of future potential. Though bank stocks have risen slightly in the past year (about 15%) there is still far more room to move. And, things are about to get hotter.

Last week, the US Federal Reserve approved buybacks and dividend increases for many of the major banks. JP Morgan, for example, is repurchasing approx. $15 billion worth of shares, having already repurchased $7 billion last year. Wells Fargo jumped its intended share buyback program from $1 billion to $6 billion. What is the significance?

Share buybacks reduce the number of shares outstanding, increasing the amount of earnings per share. For example, if you buy 100 shares today, and the company buys back 30% of its shares, you effectively own 130 shares’ worth of former value. Put another way, if there are $0.50 of earning per share now, a 30% share repurchase would give you $0.65 of earnings per share. Buybacks compound the value of your purchase.

Most banks will be buying back their shares as a mix of common and Trust Preferred Securites (TruPs), the latter of which is really a kind of debt. The common share repurchases will affect earnings per share directly, while the TruP repurchases will effectively decrease debt load and interest payments – all good things.

Stunningly (and wonderfully), despite announcing these huge stock buybacks, bank stocks have traded flat for a week! Why, you may ask?

First off, people still have an intense mistrust of US banks. Stated more bluntly, most people either fear or despise banks, and wouldn't go near them as an investment. For the rational, thoughtful investor, this is a good thing. Bank stocks are likely to remain underpriced for some time.

People also worry that the world economy is unstable, and that the banks will be spending too much money on their stock repurchases instead of holding the money for emergencies. Make no mistake… no bank wants a repeat of 2008 any time soon. Banks are repurchasing their stocks because said stocks are grossly underpriced, and because they can. The banks are sitting on hordes of cash.

Stock symbol XLF (US bank index fund), provides a great way to buy US Bank stocks with a small amount of cash. For the risk tolerant, UYG (the 2X movement stock index fund) is also available.

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"Superior risk management positioned JPMorgan to capitalize on the crisis."

Barbara Rehm, editor, American Banker

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Disclosure

Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

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The Mortgage Foreclosure Mess

YET ANOTHER KICK AT THE CAN



US Bank stocks skidded downward this week, based on a moratorium on foreclosures. Major US banks, including Wells Fargo and Bank of America, are accused of (among other things) using “robo-signers”: employees who rubber stamp foreclosure documents without properly reviewing them.

The mass-producing and bulk-signing of documents has a disgusting and immoral aura to it, similar to the revulsion for traffic tickets issued by speed radar cameras.

Having an employee decide the fate of someone’s home without reading the documentation is cold-hearted, and people are understandably upset. Having said that, it isn’t like the banks haven’t been trying. Wells Fargo alone has 17 thousand employees working on foreclosure and mortgage modification paperwork: they are simply overwhelmed by the volume.

For the banks, any moratorium on foreclosures is definitely negative. Moving foreclosed homes into the stabilized marketplace has been an order of priority for months now.

As an investor, there is a series of questions that should be asked in any situation where the immediate outlook seems negative. 1) Is this going to reduce earnings, and therefore stock prices? 2) Will this cause the company to go bankrupt, resulting in a permanent loss of capital? 3) Will the reduction in earnings be permanent?

In this case, the answers are clear: yes, this is going to reduce earnings and stock prices (and already has); no, this is not going to cause the major banks to go bankrupt (since their balance sheets are already positioned to withstand major calamities); and no, the reduction in earnings will not be permanent.

As usual, where there is fear there is opportunity.

The big chance to load up on bank stocks was in Feb-Mar of 2009, but there have been several smaller opportunities since: this may be another one. While today’s drop in bank stocks was just a small bump in the 3-year chart, a few more days of declines will result in some real bargains.

Bank of America (BAC), Citigroup (C), Wells Fargo and Co. (WFC), and JP Morgan (JPM) have all dropped nicely. That is, four of the biggest banks in America - with the greatest profit potential - are on sale again. Depending on next week's hype, bank stocks could drop even further.

If you missed out on the biggest run (when banking index fund XLF went from $6 to $15 in about a year), this is looking like another fine opportunity.

Hope for fear!

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"If I owe you a Pound, I have a problem; but if I owe you a million (Pounds), the problem is yours."

John Maynard Keynes

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Disclosure
Do not buy stocks, sell short, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

The Retail Gold Rush

Gold bullion is at record highs, and is set to rocket still higher. At least, this is the official sentiment of The London Bullion Market Association. But with prices already at record highs, is this the time to buy gold or the time to sell it?



There are two reasons commonly given to buy gold now. The first is that gold is a store of value. That is, although inflation eats away at the value of currencies, gold has a value that cannot be taken away. The second reason is that uncertainty drives gold prices higher, and today’s markets are certainly uncertain.

Gold is indeed a store of value, a currency, a component of jewelry and electronics, and more. The problem is that gold – like other commodities - usually keeps up with inflation and the business cycle but does not exceed it. In the past 3 years, however, gold has exceeded inflation greatly. Fear and speculation are the drivers of gold prices now.

Earlier this year, we saw the advent of gold-to-go machines. These vending machines hold a quote for 10 minutes, then scan the market and recalculate so the customer is always getting an up to date (but marked up) price. In Europe, these machines can be found in airports, hotels, and even supermarkets. For me, the gold-to-go machine marked the entry of retail “stupid money” into the market - money that arrives too late and stays too long.

If gold vending machines weren’t enough, consider the rise of solid or yellow gold miniatures. A few years ago, gold miniatures were an exclusive novelty. These days, the windows of high-end Chinese jewelry stores are loaded with solid gold rabbits, dragons, boars, oxen, and popular cartoon characters. The miniatures are popular with Chinese, since they offer a way to store wealth for posterity while simultaneously flaunting it.

The final sign of the gold peak is the de-hedging process of the gold producers themselves. In order to reduce income fluctuations caused by changing gold prices, most gold producers partially hedge their gold using futures or options. For example, companies buy futures that go up in value when gold goes down, and that go down in value when gold goes up. By hedging with futures, companies will not benefit as much from rising prices, but they will also not get stung by falling prices (arguably more important for profitable companies).

This year, many major gold producers have greatly reduced or even stopped hedging in the expectation of forever-rising prices. Barrick Gold, AngloGold Ashanti, Gold Fields and other companies have reduced their gold hedging by millions of ounces.

So, is gold going to drop? Should you short it?

At this point, there is still widespread fear all over the world, and this is partially justified by a worldwide housing bubble and precarious economies. Shorting gold at this point is probably not justified. However, neither is jumping on the bandwagon.

Gold prices are high – really high. Both as an investment and as a novelty, gold is more popular now than it has been in a very long time. I would refrain from buying. If you already own gold, consider selling some.

If you believe the world's currencies are being debased and you need to protect yourself, buy producers of commodities that have uses beyond merely a store of value - such as oil, uranium, lithium, and copper.

Buying something at the peak of its popularity is not always a stupid financial move, but statistics are against you.

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"My dear girl, there are some things that just aren't done, such as drinking Dom Perignon '53 above the temperature of 38 degrees Fahrenheit."

Sean Connery as James Bond, GoldFinger, 1964

The Failure of Incubator Bank

Incubator Bank of Japan, which specializes in loans to small and medium-size enterprises, filed for bankruptcy last Friday. With it, the assumed infallibility of the Japanese bank failed as well – a profound moment.

In Japan, corporations typically partner with a bank from inception, and never change. The loyalty of companies to their banks, and vice versa, is therefore extremely high. Traditionally, this meant that a bank would give loans to its corporate partners, even when it was clear that these companies were on the brink (or over the brink) of insolvency: this was considered "dedication."

The failure of Incubator Bank is profound because the bank was actually allowed to fail. The Deposit Insurance Corporation of Japan - which protects customer deposits up to 10 million yen - was instituted way back in 1971, yet this is the first time is has ever been used.

Though Incubator Bank is relatively small, large Japanese banks will recognize this as the warning shot that it is. The Government will not allow a long recession of zombie companies - barely alive - to occur again.

The Japanese financial system is coming of age, and the “modern zaibatsu” (interconnected business-banking conglomerates), are no longer untouchable. The failure of a Japanese bank is a sign that the system has become more mature, confident, and responsible. Japan Inc. has been warned.
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"Always strive to stay one step ahead. Standing still is retrogressive."

Nomura Tokuanden
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US Banks: What a Difference a Year Makes

Although recent financial news has a decidedly cataclysmic tone, evidence continues to mount that things are improving frustratingly slowly and steadily, exactly as expected.



Today, the FDIC announced that US banks earned, in aggregate, 21.6 billion dollars in the second quarter of this year (FDIC). Though this is still well below historical standards, what is striking is that most banks (80% of them) have returned to profitability.

Back in May, when I first publicly recommended bank stocks (US Banks), headlines warned that the government might force banks to be broken up and sold, that financial regulation could destroy them, and that a new debt crisis (ex. Greece) might soon cripple them. None of these things has materialized.

Since May the US financials index (XLF) has nonetheless dropped from $15.36 to $13.44, despite quantitative improvements in all areas of banking: decreased leverage, reduced loan loss provisions, increased profitability, improved credit market stability, and more.

The new worries for banks include a flattened yield curve (making credit spreads less profitable), a potential double-dip in housing, and that Barack Obama is secretly a communist Muslim and/or Biblical Anti-Christ whose intention is to destroy the US financial system.

If you truly believe that the US economy will never improve, and that US families will never again buy cars or houses, use credit cards or keep bank accounts, you should definitely stay away from bank stocks.

If you believe that banking has a future in America (and that America has a future at all), this year’s prices may well mark the single greatest buying opportunity we will see in our lifetimes.
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"After 1929, so many people had been traumatized by the stock market crash that there was a lost generation."

Ron Chernow
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Disclosure and Disclaimer

Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.
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Related amusement:

Stocks I Like - Citigroup

Citigroup – the company that almost went bankrupt in the subprime credit crisis, that received billions of dollars in government aid, and whose management has been called inept – is on my buy list.

Collectively, mutual funds and other large retail investors cannot buy Citigroup, because their unit holders would go berserk with worry. After all, the news surrounding Citigroup has been nothing short of scandalous. This situation presents an opportunity for the astute investor. For those who invest using logic rather than emotion and who can think beyond the next quarter, the big “C” is a great buy.

First off, the price: $3.79 per share at last close. This puts Citigroup shares at well below book value. As I wrote at the end of May, “At the moment, you can buy $5.61 worth of Citibank assets for $3.81, and get all their clients, brand names, and worldwide businesses for free.” And what a franchise it is.

Outside of the US, I have used Citigroup banks in Delhi, London, Tokyo and Beijing. Citigroup is a global business powerhouse, and its image - though tarnished at home - is relatively unscathed elsewhere. Citigroup’s worldwide reach is enviable.

The price of C has been hovering at just under $4 for weeks, and will likely stay there until the US government finishes selling its ownership - 2.6 billion sold so far, with 5.1 billion more to go. So, there is certainly no rush to get in. However, once the government’s stake is gone, Citigroup’s price will likely move sharply upward.

In a couple of years, I would not be at all surprised to see Citi’s EPS rise to the $2+ range, which at a modest P/E of 10 would give the shares a price of $20. Nice.

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"If a person is not willing to make a mistake, you're never going to do anything right."

Sandy Weill, former CEO of Citigroup
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Disclosure
Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

Thank you Sir, May I have Another?

It’s a terrible thing, to see a nice low limit order come tantalizingly close to being filled, only to see the stock market climb back up and away from your bid.

Financial news has been on a negativity-rampage for almost two weeks now (with a 2-day hiatus in the middle), and the markets have taken a good spanking.

Yesterday and today, news agencies pulled out all the stops, including interviews with Nouriel “Dr. Doom” Roubini, analyst Merideth Whitney (who called the market outlook “bleak,”) and even recycling frightening stories about housing from last year. Yet, the market retraced its decline today, with some financial stocks actually gaining.

Despite a stream of almost ridiculously negative headlines and advice (ex. “sell everything”), stock prices remain annoyingly unresponsive. The market is becoming desensitized. Stock news remains gloomy with stock prices to match, but another shock to the system is required.

With any luck, the U.S. financial reform bill will pass, creating enough anxiety for one more downward dive, and allowing the first tier of my low-ball orders to fill. In financial markets, one can only hope for the best of the worst.
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“You realize, you’re not in the analysis business, you are in the entertainment business.”
Fred Kittler of J.P. Morgan to analyst Andy Kessler, Wall Street Meat

America Wasn't Ready

This Sunday, the U.S. health care bill was passed after a furious battle.

The center and left were virtually silent this week, giving the limelight to those who believe that Barack Hussein Obama is not working in their best interests, to say the least. In fact, the opposition united in what both looked and sounded like a religious crusade to save America.

“We have to deny the power of the devil and his disciples in our midst,” wrote one blogger. “Pray to the father God to wake up Congress,” pleaded another. References to “rebuke,” “wickedness,” and “righteousness” were everywhere.

Then there was the coming revolution. There were calls for “bloodshed” if the bill was passed, for “revolution in the streets,” and to “impeach the foreign born dictator.” Conservative talk-show host Rush Limbaugh said that Obama’s secret goal is to divide America before destroying it, while house Minority Leader John Boehner likened the bill to "Armageddon." An ad on the Washington Post's website offered free handguns and knives to those who enrol in a self-defense training course, to prepare you "for what's coming."

The conservative right says that their hatred of Obama is politically – not racially – motivated. Casual observation suggests otherwise. One commenter on a national news website called President Obama a “lying sack of Kenyan dog crap.” Another said that he “lies through purple lips.” Yet another said that the “monkey man will get beaten.”

Of course, the health care bill passed and will now become part of American life. Citizens will have health coverage, whether they like it or not.

For investors, the big question is “what to do now?” When propaganda is rampant & emotions high, what can investors expect? At the opening bell this Monday morning, the 22nd of May 2010, two possible scenarios could occur: A) The right will demonstrate its genuine belief that Obama has destroyed their economic future by selling off U.S. stocks like mad, creating one of the largest stock market crashes in history. Or B) nothing dramatic will happen, showing that it was all just crazy talk.

Personally, I’m hoping for “A.” If so, you will find me at my computer, happily buying underpriced stocks of great American companies, while everyone else loses their minds.
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“Reactance – the urge to do the opposite of what someone wants you to do out of a need to resist a perceived attempt to constrain your freedom of choice.” Wikipedia, “List of Cognitive Biases”

Two Stocks I Like - Penny Stocks

The two stocks featured here are speculative plays. Neither company is currently netting a profit. Put another way, there is a very real possibility that these companies could fall into bankruptcy. Neither company has conclusively proven that their business model works. Nonetheless, these companies are innovative enough, and have enough “real” earnings potential to warrant some consideration. I own both.
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U-Food Restaurant Group (UFFC, OTC) www.ufoodgrill.com

U-Food Grill is a fast-food restaurant chain that focuses on healthy fast food: organic rice, low-fat cheeses, whole-grain breads, hormone-free lean meats etc. Their menu includes U.S. staples such as burgers and fries (baked), wraps, rice bowls, and salads. They currently have 10 locations in the U.S.

U-Food Grill’s official spokesperson is former heavyweight champion George Foreman, whose image is everywhere. George Foreman fits in perfectly with the healthy image of U-Food, as well as the “healthy grilled food” concept made famous by his George Foreman Grill.

U-Food initially got killed during the credit crisis, as its prices were significantly higher than traditional fast food outlets (between $8-14 per meal). Now, their prices are in line with other fast food restaurants ($5-10 per meal). The recession also, I think, helped U-Food define its long-term strategy. They recognized that their restaurants do best in areas with above-average incomes, or where there is a real demand for healthier fast food. In response, U-Food is now focusing on opening restaurants in hospitals and airports.

Stock Price (at time of writing): $0.073 USD

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HearAtLast Holdings (HRAL, OTC) www.hearatlast.com

This company is a Canadian-based retail store with 28 locations, specializing in mid- to high-end hearing aids. HearAtLast formerly opened small shops that competed with local hearing aid stores, but changed its strategy a couple of years ago, choosing instead to be co-branded with a large retailer: Wal-Mart Canada.

I visited HearAtLast’s location in the Wal-Mart megastore in Westbank BC in 2009, and got a tour of the location from the local manager. Customers who suspect hearing trouble start with a simple test using a set of headphones. If their hearing is not perfect, an appointment is made for a rigorous test in a sound-proof booth (located in back). If necessary, an appropriate make and model of hearing aid is afterward presented to the client. The store was clean, sharp, high-tech, and located right at the entrance & check-out area. Perfect.

Stock Price (at time of writing): $0.0585 USD
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Disclosure
Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

Barack’s Reforms make Big Banks Cry

Being that I own hordes of bank stocks in my personal portfolio -- and that I work for one -- you might expect me to decry President Obama’s recent pronouncement that big banks will no longer be allowed to engage in certain high-risk trading. On the contrary, I think it’s a perfectly acceptable idea, one that Wall St. professionals have known the practicality of for years.

In 1987, when markets crashed and big banks were “saved,” many thought that this set a dangerous precedent. It was believed that banks, confident that they would be bailed out no matter what their level of gambling, would start acting like hedge funds and go for broke. And they did.

So, while I am dismayed that my annual investment returns may decline a few points due to the proposed changes, I am also grateful that I won’t come back from the bathroom to find my stocks down 80%. In short, I expect my U.S. bank stocks to become more like the banks themselves: large, boring, and immensely profitable.
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“If we bail out this one (Penn Square Bank)…then the markets will know that, no matter what risks they take, the government will bail them out. Eventually, it’s going to lead down the road to nationalization of the banking system.” William Isaac, FDIC chairman, July 1982.
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“CMO equity is a particularly slippery mortgage investment. The CMO stands for Collateralized Mortgage Obligation, but bond salesmen call it ‘toxic waste.’” Michael Lewis, The Money Culture
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“I would confidently predict that most of the derivative books of major banks cannot be liquidated for anything like what they’re carried on the books at. When the denouement will happen and how severe it will be, I don’t know. But I fear the consequences could be fearsome.” Charlie Munger, Poor Charlie’s Almanac, 2005
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