This is the best passive income stock in my portfolio

I own shares of Citigroup (NYSE: C) in my portfolio and there are three reasons for thinking that it might be the best passive income stock that I hold. The company is a global provider of consumer and institutional banking services and for a start, its shares trade at a significant discount to their tangible book value. Second, the company is restructuring to improve its efficiency. And third, I think Citigroup’s dividend yield is attractive and has potential to grow.

Valuation

I think bank stocks are among the best passive income ideas for investors like me and that Citigroup shares trade at an attractive valuation. The current price is just under 75% of the tangible book value, which is significantly lower than other US banks. JP Morgan, for instance, trades at 179% of its book value. This is partly because Citigroup has significantly underperformed its peer in recent years. Its average return on equity over the last decade is around 6%, compared to 13% for JP Morgan.

But I think that its valuation prices this in. I would value US bank stocks by dividing the return on equity by the price-to-book (P/B) multiple. This calculation yields a return of 8% for Citigroup and a return of 7.26% for JP Morgan. Furthermore, while there’s an obvious risk that it will continue to underperform, I see reason to think that management is making moves to prevent this.

Restructuring

On the recent earnings call, management announced plans to wind down its consumer banking operations in 13 countries where it doesn’t have the scale to compete effectively. The aim is to allow it to concentrate its resources in the areas that provide the strongest returns. There’s clearly risk involved in this strategy, since winding down its consumer operations will incur costs. But I think its low valuation offsets this risk. I also feel the proposed restructuring gives the shares significant upside potential both now and in the long term. 

For now, management has said that winding down these businesses should free up additional capital. And I hope some of this might be returned to shareholders, either via dividends or share repurchases. In the longer term, concentrating on businesses with better prospects should help Citigroup improve its overall returns. 

Dividends

At current prices, Citigroup’s dividend yield is around 3%. As the company restructures, I hope this return will increase, again, either by distributing funds directly as dividends, or by repurchasing shares. I’d like to see it use its cash to fund share buybacks. While the stock trades below tangible book value and could continue to do so, buying back shares increases the book value of the remaining shares and increases the share of the distributed money that each holder receives. 

In my view, the combination of a low valuation, a promising restructuring process, and an opportunity for shareholder returns makes Citigroup the best passive income stock in my portfolio.