Valuation Dashboard: Financials - Update

by: Fred Piard

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 are calculated: Price/Earnings (P/E), Price to sales (P/S), Price to free cash flow (P/FCF), Return on Equity (ROE). 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.
  • They are compared with their own historical averages. The difference is measured in percentage for valuation ratios and in absolute for ROE. For valuation factors, it can be interpreted as a percentage in under-pricing relative to a historical baseline. It points to over-pricing when negative. In all cases, including ROE, the higher the better.

Industry valuation table this week

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 between the historical average and the current value. So there are 3 columns relative to P/E, and also 3 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

14.09

15.24

7.55%

2.69

2.06

-30.58%

16.57

13.44

-23.29%

8.86

8.89

-0.03

Thrifts & Mortgage Finance*

18.26

20.66

11.62%

2.79

2.03

-37.44%

20.92

14.75

-41.83%

6.1

5.02

1.08

Diversified Financial Services

21.59

17.85

-20.95%

3.72

2.94

-26.53%

17.15

16.13

-6.32%

5.16

6.38

-1.22

Consumer Finance*

8.75

13.15

33.46%

1.13

1.47

23.13%

5.49

8.22

33.21%

11.16

11.83

-0.67

Capital Markets*

13.32

18.07

26.29%

2.98

3.06

2.61%

14.89

19.62

24.11%

7.7

7.89

-0.19

Insurance

12.88

13.7

5.99%

1.14

1.07

-6.54%

10.21

8.99

-13.57%

9.02

8.71

0.31

REITs**

32.1

35.42

9.37%

4.83

4.56

-5.92%

44.04

38.74

-13.68%

5

4.07

0.93

Real Estate Management**

32.91

31.19

-5.51%

3.23

3.06

-5.56%

22.58

25.55

11.62%

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 underperformed the broad market by 4% in the last 3 months. The 5 top momentum stocks on this period in the S&P financial sector are REITs and financial services: Extra Space Storage, Inc. (NYSE:EXR), Intercontinental Exchange, Inc. (NYSE:ICE), The NASDAQ OMX Group, Inc. (NASDAQ:NDAQ), Realty Income Corporation (NYSE:O), Public Storage (NYSE:PSA). The REITs (EXR, O, PSA) hit an all-time high in January, NDAQ in December, ICE in November.

Valuation and quality factors have not changed significantly since my last update. Consumer Finance and Capital Markets are the most attractive groups in the financial sector, with all valuation factors pointing to underpricing and a quality factor close to the historical average. Real Estate Management looks more or less fairly priced, with mixed valuation ratios and quality above the baseline. Diversified Financial Services are 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 industries for the 3 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 an 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.

AMP

Ameriprise Financial, Inc.

BEN

Franklin Resources Inc.

CBG

CB Richard Ellis Group, Inc.

EIG

Employers Holdings, Inc.

ENVA

Enova International, Inc.

FBP

First BanCorp (Puerto Rico)

NAVI

Navient Corp

PFG

Principal Financial Group, Inc.

WDR

Waddell & Reed Financial Inc.

WRLD

World Acceptance Corp.

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.