Two of the best metrics that can be used to evaluate companies in the financial services sector are the price-to-book (P/B) ratio and the price-earnings (P/E) ratio.

The financial services sector includes the stocks of a variety of companies that provide financial services to retail and commercial consumers. The three primary industries within this sector are banks, investment firms and insurance companies. Investment banks are key in driving the overall financial markets, since they provide the capital that enables new corporations to begin operations and existing corporations to expand. Several financial service firms are expanding operations into emerging market economies such as India, Brazil and China.

Though the basic fundamentals of evaluation are applicable to nearly every type of firm, some critical and unique aspects of the financial services sector affect how it is valued. Companies within this sector operate under much stricter government regulations than the average corporation. Also, a key variable in evaluation of a company's soundness is debt, but a financial service firm's debt is not always easily measured or defined, thus making the firm's value and its cost of capital difficult to estimate.

The P/B ratio, also referred to as the price-equity ratio, is utilized by traders and investors to compare the book value of a stock to its market value. The P/B ratio is a formula that uses the most recent quarter's book value per share to divide the present closing price of a stock. Low P/B ratios can be an indication of stock undervaluation. This metric is suited to the evaluation of the financial services sector specifically because historical analysis has shown the ratio to very accurately track the intrinsic value of financial service firms.

The P/E ratio shows the relation of a company's stock price to its earnings and is also a favored metric for evaluating financial service firms. A high P/E ratio is interpreted as signaling increasingly higher earnings for investors. This ratio is useful in evaluation of the financial services sector by indicating the likely future growth rate of a company. Investors are careful, however, when employing both the P/B ratio and the P/E ratio to compare similar companies within the sector, such as comparing small banks to other small banks or one auto insurance company to another.

Discounted cash flow, although favored by some analysts, is a metric that is not considered particularly appropriate for evaluating companies in the financial services sector. This is because the nature of financial sector businesses often makes it difficult to specifically identify what constitutes capital expenditures and to accurately measure cash flow. More preferred evaluation metrics beyond the P/B ratio and the P/E ratio include return on equity (ROE) and the price earnings growth (PEG) ratio.

  1. What metrics can be used to evaluate companies in the banking sector?

    Learn which metrics are most useful to evaluate companies in the banking sector and associated issues with such metrics when ... Read Answer >>
  2. Why do shareholders need financial statements?

    Discover the importance of a company's financial statements for stock shareholders in evaluating their equity investment ... Read Answer >>
  3. If a company has a high debt to capital ratio, what else should I look at before ...

    Learn about some of the financial leverage and profitability ratios that investors can analyze to supplement examining the ... Read Answer >>
  4. How should I analyze a company's financial statements?

    Discover how investors and analysts use a company’s financial statements to evaluate a company's financial health and investment ... Read Answer >>
  5. What is the average price-to-earnings ratio in the oil & gas drilling sector?

    Investing in the energy sector provides an opportunity for value investors, but it is necessary to understand metrics such ... Read Answer >>
Related Articles
  1. Investing

    5 must-have metrics for value investors

    In this article, we outline the five ratios that can help value investors find the most undervalued stocks in the market.
  2. Investing

    The 4 basic elements of stock value

    Investors use these four measures to determine a stock's worth. Find out how to use them.
  3. Investing

    Sysco and Other Big Movers In Services

    The market has been slipping so far today. The Nasdaq has fallen 0.3%; the S&P 500 has fallen 0.4%; and the Dow has declined 0.5%. The Services sector (IYC) is currently lagging behind the overall ...
  4. Investing

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  5. Investing

    Analyzing GE's Price & Profitability Ratios in 2016 (GE)

    Learn about General Electric and its financial metrics that help investors analyze the company's relative valuation and profitability.
  6. Financial Advisor

    The Debt To Equity Ratio

    The debt to equity ratio identifies companies that are highly leveraged and therefore a higher risk for investors. Find out how this ratio is calculated and how you can use it to evaluate a stock.
  7. Investing

    Analyze Investments Quickly With Ratios

    Make informed decisions about your investments with these easy equations.
  8. Investing

    Comparing the P/E, EPS And Earnings Yield

    Here are three ratios that help investors value stock returns.
  9. Investing

    How To Use The P/E Ratio And PEG To Tell A Stock's Future

    The P/E ratio is used to calculate stock price valuation. However the PEG ratio includes earnings growth and can provide insight as to whether the P/E valuation is justified.
  1. Ratio Analysis

    A ratio analysis is a quantitative analysis of information contained ...
  2. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  3. Accounting Ratio

    Accounting ratios, also known as financial ratios, are used to ...
  4. Liquidity Ratios

    Liquidity ratios are a class of financial metrics used to determine ...
  5. Metrics

    Metrics are parameters or measures of quantitative assessment ...
  6. Coverage Ratio

    A coverage ratio is a measure of a company's ability to service ...
Hot Definitions
  1. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  2. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  3. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  4. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  5. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  6. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
Trading Center