When interest rates are on the rise, bank stocks become a great buy. That’s because of what’s known as net interest margin, which is the difference between the interest that banks earn on assets and the interest paid to depositors and creditors. When the Federal Reserve raises interest rates as its doing this year, the net interest margin also increases. Banks make more money.
“Basically banks are in the business of buying and selling money. It’s a very pure business and so the rates, the spread between what they borrow or your savings rate and what they lend, your lending rate is how they make their money,” said Motley Fool contributor Lou Whiteman on an Apr. 11 podcast. “Almost universally, the rates on the lending side go up first, so the banks in a typical time have a real chance in a rising interest rate environment.”
A lot of investors already know this, of course. So, the trick today is to find undervalued bank stocks that still have plenty of room to run in a rising interest rate environment. For this exercise, I screened for diversified banking stocks with a forward price-to-earnings (PE) ratio of 10 or less. Forward PE is one of the best indicators of value when evaluating stocks.
Because we want to get some extra bang for our buck, I also limited the screen to bank stocks that offer a dividend yield of at least 2%. And finally, I chose bank stocks that have a consensus analyst rating of “hold” or better.
Citigroup (C)
Forward PE: 67.47
Dividend yield: 3.91%
Citigroup (NYSE:C) traces its roots all the way back to 1812 and the City Bank of New York. Now it’s a global bank serving hundreds of cities and countries with a market capitalization of nearly $100 billion.
Usually, Citigroup has a pretty low-key reputation, although it made some unwelcome news this week when it acknowledged a “large erroneous transaction” by someone on its London trading desk triggered a flash crash by as much as 8% on some European stocks. The mistake wiped out $315 billion in market capitalization before the stocks recovered.
But that’s not a reason to avoid C stock. For the first quarter (Q1) of the year, Citigroup announced that it beat analysts’ expectations for both profit and revenue. It posted revenue of $19.19 billion versus analysts’ expectations of $18.15 billion. And it earned $2.02 per share versus expectations of $1.55 per share.
The company is also planning to sell its consumer and commercial banking business in Russia, which would eliminate the bank’s exposure to that country. Citi had previously announced it was setting aside $1.9 billion for potential loan losses related to Russia and the country’s war in Ukraine.
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