Valuation Dashboard: Financials - Update

| About: Financial Select (XLF)

Summary

4 key factors are reported across industries in the Financial sector.

They give a valuation status relative to history.

They give a reference for picking stocks in each industry.

This monthly series of articles provides a valuation dashboard in sectors and industries. I follow up a certain number of fundamental factors and compare them to historical averages. This article covers Financials. The choice of the fundamental ratios used in this study has been justified here and here. You can find in this article numbers that may be useful in a top-down approach. There is no analysis of individual stocks. A list of stocks to consider is provided in the conclusion.

Methodology

  • Four industry factors calculated by portfolio123 are extracted from the database: Price/Earnings (P/E), Price to sales (P/S), Price to free cash flow (P/FCF), Return on Equity (ROE).
  • They are compared with their own historical averages "Avg". The difference is measured in percentage for valuation ratios and in absolute for ROE, and named "D-xxx" if xxx is the factor's name. For example, D-P/E = (AvgP/E - P/E)/AvgP/E. It can be interpreted as a percentage in under-pricing relative to a historical baseline: the higher, the better. It points to over-pricing when negative. ROE is already a percentage. That's why we take the simple difference: D-ROE = ROE - AvgROE.

The industry factors are proprietary data from the platform. The calculation aims at eliminating extreme values and limiting the influence of the largest companies. These factors are not representative of capital-weighted indices. They are useful as reference values for picking stocks in an industry, not for ETF investors.

Industry valuation table on 1/8/2016

The next table reports the 4 industry factors. For each factor, the next "Avg" column gives its average between January 1999 and October 2015, taken as an arbitrary reference of fair valuation. The next "D-xxx" column is the difference as explained above. So there are 3 columns for each ratio.

P/E

Avg

D- P/E

P/S

Avg

D- P/S

P/FCF

Avg

D- P/FCF

ROE

Avg

D-ROE

Commercial Banks

14.91

15.24

2.17%

2.84

2.06

-37.86%

17.5

13.44

-30.21%

8.82

8.89

-0.07

Thrifts & Mortgage Finance*

18.93

20.66

8.37%

2.9

2.03

-42.86%

21.55

14.75

-46.10%

6.11

5.02

1.09

Diversified Financial Services

22.07

17.85

-23.64%

3.93

2.94

-33.67%

17.76

16.13

-10.11%

5.16

6.38

-1.22

Consumer Finance*

9.46

13.15

28.06%

1.18

1.47

19.73%

6.05

8.22

26.40%

10.98

11.83

-0.85

Capital Markets*

14.25

18.07

21.14%

3.22

3.06

-5.23%

16.84

19.62

14.17%

7.5

7.89

-0.39

Insurance

13.31

13.7

2.85%

1.19

1.07

-11.21%

10.6

8.99

-17.91%

9.06

8.71

0.35

REITs**

32.68

35.42

7.74%

5.02

4.56

-10.09%

45.05

38.74

-16.29%

5.05

4.07

0.98

Real Estate Management**

33.56

31.19

-7.60%

3.39

3.06

-10.78%

21.96

25.55

14.05%

2.66

-1.33

3.99

Click to enlarge

* Averages since 2003 - ** Averages since 2006

Valuation

The following charts give an idea of the current status of industries relative to their historical average. In all cases, the higher the better.

Price/Earnings:

Price/Sales:

Price/Free Cash Flow:

Quality (ROE)

Relative Momentum

The next chart compares the price action of the SPDR Select Sector ETF (XLF) with SPY (chart from freestockcharts.com).

Click to enlarge

Conclusion

XLF has slightly underperformed the broad market in the last 3 months. The 5 top momentum stocks on this period in the S&P financial sector are all REITs: Equinix Inc (NASDAQ:EQIX), Macerich Co (NYSE:MAC), Realty Income Corp. (NYSE:O), Plum Creek Timber Co (NYSE:PCL), Public Storage (NYSE:PSA).

With the ongoing correction, the P/E factors have significantly improved. Commercial banks skip in positive territory for P/E (undervaluation). The most attractive industries seem to be Consumer Finance (with all valuation factors above historical averages and the quality factor just below) and Real Estate Management (with mixed data for valuation and a quality factor above the average). Diversified Financial Services look the less attractive, with all factors in negative territory.

However, there may be quality stocks at a reasonable price in any industry. To check them out, you can compare individual fundamental factors to the industry factors provided in the table. The next table shows a list of stocks in the Financial sector. They are all cheaper than their respective industry for 3 of the most relevant valuation factors simultaneously: Price/Earnings, Price/Sales, Price/Free Cash Flow. Then they are selected for their higher Return on Equity. This screen updated and rebalanced monthly has an annualized return about 10.1% with a 72% drawdown for a 17-year backtest. The sector ETF XLF has an annualized return of only 2.24% with a 84% drawdown on the same period. Past performance, real or simulated, is not a guarantee of future return. This list may be considered an entry point for further due diligence, or as a portfolio after adding a few trading rules and market timing. This is not investment advice. Do your own research before buying.

AFL

AFLAC Inc

INSURANCE

AMP

Ameriprise Financial Inc

CAPMARKET

BEN

Franklin Resources Inc

CAPMARKET

CBG

CBRE Group Inc

REMGMT

EIG

Employers Holdings Inc

INSURANCE

ENVA

Enova International Inc

CONSUMERFIN

FBP

First BanCorp (Puerto Rico)

BANKCOMM

NAVI

Navient Corp

CONSUMERFIN

WDR

Waddell & Reed Financial Inc.

CAPMARKET

WRLD

World Acceptance Corp

CONSUMERFIN

Click to enlarge

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.