Valuation Dashboard: Financials - Update

| About: Financial Select (XLF)

Summary

4 key fundamental factors across industries in the Financial sector.

A valuation status relative to history.

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 on 2/22/2016

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 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

14.13

15.24

7.28%

2.73

2.06

-32.52%

17.01

13.44

-26.56%

8.74

8.89

-0.15

Thrifts & Mortgage Fin.*

17.99

20.66

12.92%

2.76

2.03

-35.96%

19.66

14.75

-33.29%

6.05

5.02

1.03

Diversified Fin. Services

20.97

17.85

-17.48%

3.52

2.94

-19.73%

18.02

16.13

-11.72%

6.24

6.38

-0.14

Consumer Finance*

8.88

13.15

32.47%

1.07

1.47

27.21%

5.44

8.22

33.82%

10.94

11.83

-0.89

Capital Markets*

13.54

18.07

25.07%

2.98

3.06

2.61%

14.4

19.62

26.61%

7.26

7.89

-0.63

Insurance

13.41

13.7

2.12%

1.15

1.07

-7.48%

10.11

8.99

-12.46%

8.89

8.71

0.18

REITs**

32.62

35.42

7.91%

4.82

4.56

-5.70%

43.96

38.74

-13.47%

5.22

4.07

1.15

Real Estate Management**

27.27

31.19

12.57%

2.91

3.06

4.90%

20.91

25.55

18.16%

3.67

-1.33

5

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. The higher is 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 7% in the last 3 months. The 5 top momentum stocks on this period in the S&P financial sector are: Extra Space Storage Inc (NYSE:EXR), Nasdaq Inc (NASDAQ:NDAQ), Realty Income Corp. (NYSE:O), Public Storage (NYSE:PSA), Ventas Inc. (NYSE:VTR). Four of them are close to an all-time high: EXR, O, PSA, NDAQ.

Most valuation factors are quite stable since last month. P/E and P/FCF have improved for Real Estate Management. P/FCF has also improved in Thrifts & Mortgage Finance, and deteriorated a bit in Diversified Financial Services. There is a small improvement in quality (ROE) for Real Estate Management and Diversified Financial Services. Real Estate Management is the most attractive group, with the four valuation and quality metrics above the baseline. Consumer Finance and Capital Markets are also looking good, with valuation factors pointing to underpricing and the ROE factor very close below the historical average. Diversified Financial Services seems to be the most overpriced industry in the financial sector.

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 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 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.

AMP

Ameriprise Financial Inc

CBG

CBRE Group Inc

ENVA

Enova International Inc

ITG

Investment Technology Group Inc.

JLL

Jones Lang LaSalle Inc

NAVI

Navient Corp

OFC

Corporate Office Properties Trust Inc

PRU

Prudential Financial 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.