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 metrics can be used to evaluate companies in the financial services sector?

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  2. When does a growth stock turn into a value opportunity?

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  3. What is considered a good price to book ratio?

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

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  5. What is the average price-to-book ratio in the oil & gas drilling sector?

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