A value investor is drawn to investing in the financial services sector for two principal reasons. First, financial service firms are proven to be solid, growth investments providing very good returns on equity over the years. The second reason is that the price-to-book ratio, the favored equity valuation metric of classic value investors, is well-suited for comparisons of companies in the financial services sector.

The financial services sector includes credit unions and banks, both regular retail banks and investment banks, the insurance industry, and brokerage and investment advisory firms. The largest portion of the industry is made up of insurance firms, companies that earn revenues from policy premiums and financial market investments. Investment banks are a critical influential factor in all financial and equity markets, since the funding they provide for growth, mergers and acquisitions not only impacts the success of the specific companies involved but also plays a large part in driving the U.S. economy as a whole.

Price-to-book ratio, or P/B ratio, directly compares the share market price of a company to its book value of assets. This ratio works well for equity valuation and comparison of financial firms, especially banks, since the equity they have invested is their principal business. For financial firms, investment capital is, in essence, the "product" they market. P/B value can be an excellent tool for investors and analysts in attaining the goal of value investing, to identify currently undervalued companies with excellent prospects for growth.

Value investing is virtually inseparable from growth investing. After all, an undervalued company is not inherently a good investment simply because it appears to be undervalued. It is only a truly good investment if the company has solid growth prospects. For this reason, another important evaluation metric for use in analyzing companies in the financial services sector is the price-to-earnings ratio, or P/E, or alternatively the price/earnings to growth, or PEG, ratio. Either of these two metrics can be helpful to value investors in providing supplemental analysis beyond the P/B ratio, particularly the PEG ratio, since this more complete valuation measure helps to distinguish the likely future growth prospects of similar firms.

Value investing is an old stock market investing strategy that originated in the 1930s principally by Benjamin Graham; it remains very useful and is still practiced by legendary investors such as Warren Buffet, the creator of the phenomenal stock success story of Berkshire Hathaway. Value investing encompasses consideration of revenues, dividends, book value and cash flow. Each of these elements can be important in the analysis of a company's stock, but all of them are considered especially applicable to evaluation of companies in the financial services sector. The most successful companies in this sector typically rate well across the whole spectrum of evaluation, another factor that makes them fundamentally appealing to value investors.

When evaluating companies in the financial services sector, it is important for investors to compare like to like. It is not appropriate to run value comparisons between a bank and an insurance company, or even between a small, regional bank and a large investment bank. Within this far-reaching industry, there are many opportunities for value investors to consider.

  1. What is a typical price-to-book ratio in the financial services sector?

    Understand key distinctions of the financial services sector and learn some of the equity valuation metrics analysts use ... Read Answer >>
  2. How do you use the price-to-book ratio to evaluate a company's value?

    Understand how investors and market analysts use the price-to-book ratio to evaluate the worth of a company and why this ... Read Answer >>
  3. If a company has a low price to book ratio, does this mean its stock is undervalued?

    Learn the usefulness of the price-to-book ratio, a primary equity valuation measure, and determine how it can best be used ... Read Answer >>
  4. 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 >>
  5. What is the average price-to-book ratio in the oil & gas drilling sector?

    Calculating the price to book ratio for oil and gas drilling companies can provide insight for investors interested in understanding ... Read Answer >>
  6. What price metrics can be used to compare companies in the industrial sector?

    Discover some of the best equity evaluation measures that investors and analysts commonly use for comparing companies in ... Read Answer >>
Related Articles
  1. Investing

    How to Invest Your Excess Cash in Undervalued Securities

    Learn how even small investors can shoot for substantial capital gains by starting to invest their excess cash in undervalued securities.
  2. Investing

    5 Must-Have Metrics for Value Investors

    These quick-and-dirty ratios will help you find the most undervalued stocks on the market.
  3. Investing

    Using The Price-To-Book Ratio To Evaluate Companies

    The P/B ratio can be an easy way to determine a company's value, but it isn't magic!
  4. Investing

    Book Value Per Share for Banks: Is It a Good Measure? (WFC, BAC)

    Find out why bank stocks usually trade below book value per share, and understand how trading activities increase banks' risk exposures and affect valuation.
  5. Investing

    5 Must-Have Metrics For Value Investors

    Focusing on certain fundamental metrics is the best way for value investors to cash in gains. Here are the most important metrics to know.
  6. Investing

    Wal-Mart's 5 Key Financial Ratios (WMT)

    Identify the five key financial ratios that fundamental analysts use to evaluate Wal-Mart's financial position and determine if its stock is a good buy.
  7. Investing

    What Is The Value In Value Investing?

    Value investing has its advantages, but it also has significant drawbacks. We look at the pros and cons.
  8. Investing

    Does Active Value Investing Pay Off?

    Learn about a well-researched paper that explores why active value investors underperform, and how value investing might be beneficial for your portfolio.
  1. Value Stock

    A stock that tends to trade at a lower price relative to it's ...
  2. Financial Sector

    A category of stocks containing firms that provide financial ...
  3. Book Value

    1. The value at which an asset is carried on a balance sheet. ...
  4. Value Fund

    A value fund is a fund that follows a value investing strategy ...
  5. Relative Value

    A method of determining an asset's value that takes into account ...
  6. Undervalued

    A financial security or other type of investment that is selling ...
Hot Definitions
  1. Time In Force

    Time in force is a special instruction used when placing a trade to indicate how long an order will remain active before ...
  2. Retirement Planning

    Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve ...
  3. Drawdown

    The peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted ...
  4. Inverse Transaction

    A transaction that can cancel out a forward contract that has the same value date.
  5. Redemption

    The return of an investor's principal in a fixed income security, such as a preferred stock or bond; or the sale of units ...
  6. Solvency

    The ability of a company to meet its long-term financial obligations. Solvency is essential to staying in business, but a ...
Trading Center