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Why Citigroup's Latest Move Is So Smart

Citigroup (NYSE: C) announced on Wednesday that it will double its quarterly dividend and increase the amount of common stock it repurchases over the next 12 months by $15.6 billion. Both moves have been well-received by the market, as Citigroup's shares are up more than 2% today, but it's the latter one that's particularly smart.

There are two ways for a bank, or any company for that matter, to return capital to shareholders. Dividends are one way. Share buybacks are another.

Most banks prefer to spend roughly a third of their annual earnings on each of the two, while retaining the final third to fuel organic growth. Citigroup, however, is heavily favoring buybacks over dividends. Its planned capital actions over the next 12 months total $18.9 billion, with buybacks accounting for 83% of that.

Data source: Citigroup.

While Citigroup has certainly made its fair share of errors in the past when it comes to buying back stock, its decision to heavily favor buybacks over dividends throughout the next 12 months should be welcome news to its shareholders.

This is because Citigroup's stock currently trades for one of the lowest valuations among big bank stocks. Of the two dozen large-cap banks on the KBW Bank Index, only shares of Capital One Financial currently sport a lower price-to-book multiple.

Citigroup's shares trade at a 12% discount to book value. That compares to a 50% premium for the average blue chip bank stock. Any buybacks that Citigroup executes at this valuation, in turn, will necessarily boost its book value per share, as the bank will be paying $0.88 for every $1 worth of book value that it repurchases.

Michael Corbat, CEO of Citigroup. Image source: Citigroup.

It's for this reason, combined with the sheer size of Citigroup's planned capital actions, that the bank's executives are sounding an especially optimistic note. CEO Michael Corbat noted yesterday in prepared remarks:

Today marks a significant milestone for Citi and our shareholders. This year's [Comprehensive Capital Analysis and Review] results demonstrate that Citi has the ability to withstand a severe economic scenario and remain well capitalized, while also substantially increasing our level of capital return. For some time, we have retained a significant amount of capital in excess of what is needed to prudently operate and invest in the firm. Now we can begin delivering on two of our most important priorities -- returning a higher level of that capital to our shareholders and improving Citi's overall returns.

To be clear, Citigroup still has considerable ground to make up since the financial crisis nine years ago. Missteps in the lead-up to the downturn obligated the bank to more than quadruple its outstanding share count at a time when its shares traded for a quarter of book value. By doing so, Citigroup egregiously diluted its shareholder value, which explains why its share price is still 90% below its pre-crisis peak.

Citigroup's newly disclosed $15.6 billion share-buyback plan won't single-handedly reverse this dilution, but it will help the New York-based bank begin to meaningfully chip away at it.

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John Maxfield has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.