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 series provides a valuation dashboard using the GICS classification. Each sector is covered once a month. This issue covers Financials. It aims at giving reference values for a top-down approach across industries. A list of stocks to consider is offered in the conclusion without detailed analysis.

Methodology

I take 4 aggregate industry factors provided by portfolio123: Price/Earnings (P/E), Price to sales (P/S), Price to free cash flow (P/FCF), Return on Equity (ROE). My choice has been justified here and here. Their calculation aims at limiting the influence of outliers and large caps. They are reference values for stock picking, not for capital-weighted indices.

For each factor I calculate the difference with its own historical average: to the average for valuation ratios, from the average for ROE, so that the higher is always the better. The difference is measured in percentage for valuation ratios, not for ROE (already in percentage).

Industry valuation table on 4/11/2016

The next table reports the 4 industry factors. There are 3 columns for each factor: the current value, the average ("Avg") between January 1999 and October 2015 taken as an arbitrary reference of fair valuation, and the difference explained above ("D-xxx").

P/E

Avg

D- P/E

P/S

Avg

D- P/S

P/FCF

Avg

D- P/FCF

ROE

Avg

D-ROE

Commercial Banks

14.52

15.24

4.72%

2.82

2.06

-36.89%

17.68

13.44

-31.55%

8.8

8.89

-0.09

Thrifts & Mortgage Fin.*

18.12

20.66

12.29%

2.91

2.03

-43.35%

18.53

14.75

-25.63%

6.19

5.02

1.17

Diversified Fin. Sces

21.09

17.85

-18.15%

3.57

2.94

-21.43%

20.93

16.13

-29.76%

7.68

6.38

1.3

Consumer Finance*

9.87

13.15

24.94%

1.19

1.47

19.05%

5.38

8.22

34.55%

10.46

11.83

-1.37

Capital Markets*

16.39

18.07

9.30%

3.34

3.06

-9.15%

14.98

19.62

23.65%

6.45

7.89

-1.44

Insurance

13.95

13.7

-1.82%

1.22

1.07

-14.02%

10.62

8.99

-18.13%

8.85

8.71

0.14

REITs**

32.94

35.42

7.00%

5.43

4.56

-19.08%

45.56

38.74

-17.60%

5.81

4.07

1.74

Real Estate Management**

35.47

31.19

-13.72%

3.33

3.06

-8.82%

24.88

25.55

2.62%

4.67

-1.33

6

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 about 8% in the last 3 months. The 5 top momentum stocks on this period in the S&P financial sector are: Cincinnati Financial Corp (NASDAQ:CINF), Iron Mountain Inc (NYSE:IRM), Nasdaq Inc (NASDAQ:NDAQ), Realty Income Corp. (NYSE:O), Progressive Corp (NYSE:PGR). All except IRM have reached an all-time high in the last weeks.

Since last month, Diversified Services have improved in P/E, but deteriorated in P/FCF. Real Estate Management has deteriorated in both. P/FCF has improved in Capital Markets. Other factors are relatively stable.

According to these metrics, the two most attractive groups are Consumer Finance and Real Estate Management. The first one looks undervalued and has a quality factor close below the baseline. The second one may be a bit overpriced, but the quality factor is significantly above its historical average. The Capital Markets group is not so bad, a bit undervalued and close below the baseline in quality. All valuation factors points to an overpricing in Diversified Services and Insurance.

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

INN

Summit Hotel Properties Inc

NAVI

Navient Corp

OFC

Corporate Office Properties Trust Inc

PFG

Principal Financial Group Inc.

PRU

Prudential Financial Inc

UVE

Universal Insurance Holdings

WRLD

World Acceptance Corp

Click to enlarge

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Data provided by portfolio123.

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.