People think of banks when they hear “financial sectors”. This is the largest sector of the financial sector. However, the sector also includes many other types companies.
Top financial stocks to help beginners
These are some smart investments for novice investors that are easy to understand and have a mature financial sector business.
Berkshire Hathaway NYSE:BRK.A (NYSE:BRK.B). Although not considered a financial stock, it is an insurance company. Berkshire, led by Warren Buffett is the parent company to GEICO and has a large reinsurance business. Investors in the company have access to its vast stock portfolio which includes large stakes at several of the largest U.S. bank branches.
JPMorgan Chase(NYSE:JPMM) is America’s largest bank, and also the largest company in the financial industry. JPMorgan Chase is an attractive investment. The bank has large operations in both consumer and investment banking and consistently ranks among the best in the industry in terms of profitability.
Visa(NYSE:V), operates the largest global payment network and has, together with Mastercard [NYSE:MA] half of the near-duopoly in the payment processing sector. Visa isn’t a small company, so don’t mistakenly think it doesn’t have the potential to grow. The company currently processes $12 trillion in annualized payments per year. That’s a tiny slice of the global cashless money market that Visa management values at $185 billion.
The Vanguard Financials (NYSEMKT.VFH), may be the best financial sector ETFs (ETFs). The fund offers portfolio exposure to the entire financial industry and a low 0.1% expense ratio (annual fee). The fund gives exposure to 377 financial sector stocks. This is weighted according the market capitalizations. (More assets of the fund are invested in larger financial institutions. Other than the three mentioned companies, the top holdings are Bank of America(NYSE.BAC), Citigroup [NYSE.C], BlackRock—NYSE.BLK), Morgan Stanley [NYSE.MS].
Different types of financial stock
Apart from banks, there are many other types of companies that make up the financial industry. There are many factors that influence the function and size of financial companies.
You can break financial stocks into many categories:
Banks The financial sector is dominated by bank stocks. These include banks that provide loans and deposit accounts to individuals and businesses, as well as investment banks like Goldman Sachs, which provides services to institutions and high net-worth investors. Universal banks such JPMorgan Chase serve both commercial and institutional customers.
Insurance This is the second-largest sector of the financial market. It includes specialty insurances, life and medical insurers, property and casualty, and brokers. Berkshire Hathaway, the largest company in that sub-sector of the insurance industry, is also the largest. This includes so-called “insurtech”, such as Lemonade(NYSE:LMND).
Services in financial services: Some businesses provide services that are related to investing or the public markets but are not classified as insurers or banks. There are two types of financial service providers: the S&P Global rating agency (NYSE :SPGI) or the futures exchange CME Group NYSE :CME.
Mortgage REITs Other financial institutions such as mortgages, are known as mortgage realestate investing trusts (REITs).
Fintech: Fintech companies are those that use technology in order to provide new solutions for the financial market. This group includes PayPal Holdings, Visa, Block (NYSE.SQ), and Square (previously known as Square).
Blockchain and Cryptocurrencies: A number of financial companies use blockchain technology to develop products and sell services.
SPACs An SPAC (special purpose acquisition company) is a company without any business operations that exists to make another company public. SPACs, also known by the name “blank check”, are part of financial sector.
Analyzing financial sector investments
Investors can assess financial industry investments using both the traditional metrics (P/E ratio) and those specific to this sector. Investors should be aware of some key metrics in the banking and insurance subsector of the financial sector.
These metrics can be especially helpful for analysing bank stocks.
Return of equity (ROE), and return on assets(ROA): These two metrics are the most used to measure bank profitability. ROE is a company’s annualized profits expressed in percentages, shareholders equity, and total assets. The industry benchmarks for ROE and ROA are generally 10% and 1%, respectively.
Net interest margin Many banks make the bulk of their profits simply by lending money and charging customers interest. Net interest margin is the difference in the average interest rate received by a bank and the rate it pays.
Efficiency Ratio: This measure of how much a bank spends in order to generate revenue. A 60% efficiency ratio, for example, means that a bank would spend $60 to generate each $100 of revenue. Lower efficiency ratios are better.
Net charge off (NCO) ratio The NCO ratio shows the bank’s annualized percentage of loans it writes off as bad.
Price to book (P/B) ratio For valuing bank stock stocks, the price–to-book-value ratio may be as useful and as reliable as the P/E. The P/B is the company’s stock market price divided by its total net asset value. The price-to-tangible-book-value (P/TBV) ratio may be even more useful than the P/B ratio because it excludes assets tough to value such as brand names and goodwill.
Two key metrics are important for analysing stocks that have insurance:
Combination ratio: To find this ratio, you must first add (combine the amounts paid out by an insurance company in claims) the amount spent on other business expenses. Divide this amount by the premium income the insurance company receives and verify that it is less than 100 percent. A lower combined ratio means that the insurer is making more profit.
Investment margin Insurers make money underwriting policies, but also invest the premiums collected to pay for insurance claims. Investment income can often be the most important source of profit for insurance companies. It is therefore vital that an insurer’s investment margin is high.
Invest long-term in financial services
Bank stocks were some of the worst performers during COVID-19. Bank stocks and other financial stocks can be cyclical. This means that they are susceptible to losing value during economic recessions. Businesses and consumers often have difficulty paying their bills as a result of rising unemployment. This can cause banks to incur large amounts in bad debt.
When analyzing a company’s financial outlook, take into account all metrics and not just one. Remember that financial sector stocks work best as long-term investment vehicles.
Many factors can have an impact on financial stock prices, but they are often not related to the business’s performance. A good investment strategy is to add financial sector stocks that have a longer time horizon than five years.
