The Long and the Short of It
By Michael Hlinka
I’m writing this column the day before April Fool’s, which strikes me as both appropriate and somewhat ironic. Now, if I’m doing my job, you should understand what I mean in no more than 500 words! Let’s roll.
We’re at the tail end of the Silicon Valley Bank (SVB) crisis. In a nutshell, here’s what happened: if you’re a bank, the majority of liabilities are in the form of deposits, and SVB had a lot of deposits. The bank takes those deposits and either lends them out or invests in “safe” long-term government bonds. Why do I put the word “safe” in quotation marks? Because they’re safe in the sense that they have zero default risk, but when interest rates increase, those bonds drop in price and the mark-to-market value of the bank’s assets will be less than the liabilities. In this case, it translated to bankruptcy.
However, I believe that Silicon Valley and other smaller regional banks are a special case. The fall-out presents a wonderful buying opportunity for bigger, better capitalized banks and I’m recommending that you look at very carefully. The closing price of Citigroup Inc (NYSE: C) on Friday March 31st, 2023, was USD$46.89.
This is what the market is missing. We’re in the midst of a capital flight from the smaller regional banks to larger money-center banks like Citibank. This means that when the “Big Boys” get those deposits, their balance sheets are buttressed. I’m being technical here, but if you revalued C’s assets as of the end of 2022 and wrote its goodwill down to zero, its clean book value is $80 per share.
Simply put: If Citibank cashed in all of its assets, paid off all of its liabilities, and then distributed what was left over, each share would be worth $80. The fact that the share price is close to half of that strikes me as foolish… and $80 is my two-year price target.
When I look for companies to short, I try to identify those that I think could be out of business in the foreseeable future, but there are sometimes intelligent exceptions. The short pick this month is a company that I expect will be around for a very long time, but whose valuation makes absolutely no sense; chipmaker NVIDIA Corporation (NASDAQ:NVDA) closed at a price of USD$277.77 on March 31st, 2023.
NVDA has impressive intellectual content, it’s a great company, but sometimes there more to the equation. Sometimes a great company doesn’t equal a great but (in terms of the share price), and NVIDIA seems to have gotten ahead of itself by a wide margin. Sales flatlined from 2021 to 2022 while at the same time its gross profit margin slid by 800 basis points. R&D expenses soared over the past two years and I wonder whether this isn’t an ongoing reality, given the new markets it must exploit to keep growing its top line. The number that makes me most nervous about NVDA is its price to sales ratio. It trades at 25 times P/S, which seems foolishly excessive. If and when common sense returns to NVDA’s pricing, this stock could easily be cut in half if not more. My two-year price target is $135 and we’ll call it a day.
Bottom line
2-year price target for C: $80 (March 31st close: $46.89)
2-year price target for NVDA: $135 (March 31st close: $277.77)
All articles published by PAIP Canada Inc. are for informative purposes only and does not constitute advice. We recommending consulting by a subject matter expert before making any financial decision(s).