Citigroup Inc.

Citigroup Inc.

Watch out for the earnings trap… It is not just Citigroup, but as a holder of Citigroup (C) stock it is the one that caught my attention. Today Citigroup beat earnings estimates, and the stock is up almost 6%.

So if the company beat earnings estimates what “trap” am I talking about? The “trap” I’m referring to is the practice of using cash reserves to cover bad loans. As one analyst put it “Reducing loan loss reserves is not something you can do indefinitely”.

If you look at just the top line and bottom line you can see where the problem is. While they beat on the bottom line, the top line (revenue) is lower than their second quarter. So they have actually beat expectations in the near-term (likely why the stock is up today), but their revenue dipping does not inspire confidence for their long-term prospects. Further to that, they used cash reserves to cover bad loans. As mentioned above, this is not sustainable for the long-term.

I currently hold Citigroup (C), and do not plan to sell (I have a small loss) on this spike. What this spike does is that it raises concerns about when they might be back to real profitable. I would fully expect that this stock can break the $5 barrier when the economy starts to make a recovery, but caution those who think it will go up three-fold from here.

The chance to make a 20%-25% gain is there in the medium to long-term, but I do not see the 300% gain many are hoping for. The biggest risk is getting in at these prices and expecting something to happen in the very near-term. For a medium-term play I think $5 is a real target, perhaps $6 if the housing and credit markets recover quicker than expected. Just don’t look at today’s “beat” of earnings as a strong sign of their health.