YCG Investments
“If you buy above average businesses at below average prices, on average, we believe you should come out ahead.” — Brian Yacktman

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Yesterday, Citigroup broke below a buck! Yep, that same behemoth of a bank that was once trading above $55 dropped below $1/share.

It reminds me of an article I read somewhere about a year ago. It was titled something like “Citigroup: Do as we say, not as we do.” I recall that it pointed out the irony of Citi analysts urging investors to avoid leveraged businesses. They were essentially issuing a very strong sell recommendation on their very own stock!

I’d like to take you back to something we wrote in our Q3 2008 letter:

“Amidst all of this turmoil, the financial sector has taken a beating. Fortunately, your portfolio has had very low exposure to financials, especially relative to the S&P 500 index. One might think that we’d be sifting through the financial bargain bin now that this sector has plunged, but in this instance, this is not the case. We continue to have an aversion toward most financials.

Many value investors generally find financials attractive because of their low P/E multiples, which make them appear cheap. However, when you strip out the leverage, they actually trade in line with other stocks.

We also do not like the risk associated with banking assets themselves. No bank can pay back all of their deposits on demand, and thus none of them are immune from a “run on the bank.” During a panic, nobody sticks around because they think “this bank has crisper dollars” – money is simply a commodity.

Finally, banks are generally leveraged anywhere from 10, 15, and even 20 to 1. This means that for every dollar of assets lost that is not offset by fresh capital, the bank needs to shrink its assets by $10-20 to maintain adequate capital. Since banking assets can be written with the stroke of a pen, the problem is ascertaining which companies have fake versus accurate book values. Not even the management of these major financial institutions truly know what is on their balance sheets. As an analyst, a minor error in estimating true book value could mean the difference between a fabulous investment and bankruptcy.

Therefore, despite the seemingly attractive price to book values of many financials, we remain hesitant to invest in this sector due to the lack of transparency, resulting in an inability to properly value the banking assets. We want you to take comfort in knowing that we will continue to be extremely cautious before committing any capital in this sector."

Fortunately, we have avoided Citigroup. At this point, could you make a lot of money here? Sure, it’s possible. You might win big on a slot machine, too. It’s such a black box, we have no idea what we’d be buying here. And even if Citi does survive, it doesn’t mean the shareholders won’t lose their shirts. We prefer to invest, and not speculate.

Disclaimer: The specific securities identified and discussed should not be considered a recommendation to purchase or sell any particular security. Rather, this commentary is presented solely for the purpose of illustrating YCG’s investment approach. These commentaries contain our views and opinions at the time such commentaries were written and are subject to change thereafter. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. These commentaries may include “forward looking statements” which may or may not be accurate in the long-term. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable. Past performance is no guarantee of future results.

Posted by: Brian Yacktman | March 06, 2009 | Permalink

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