What Works With Financials

9/4/2017


No sector has more stocks in Quadrix than financials. Today, there are 901 in our research universe, or 19% of the 4,801 stocks. Just over year ago, the financial sector also included real estate companies, which pushed the total count above 1,100.

To say financials are important in Quadrix is an understatement. So, we set off to find which scores work best in the sector, comparing returns for the top 20% of financials across the six category scores and Overall rank. We used rolling 12-month holding periods for stocks in the S&P 1500 Index since 1999.

We also evaluated which individual factors work best in four core financial industries — capital markets, commercial banks, insurance, and thrifts — using data back to 2003. Among our findings:

• For all financials in the S&P 1500, the top 20% based on Overall score outperformed the average financial stock by 2.1% per year, on average. Among category scores, Value worked best — as it often does in back-tests — generating an average outperformance of 6.0%. The Momentum and Financial Strength scores also worked.

• Nine of the 20 factors are Value metrics, with price/book and estimated price/earnings ratio versus the median three-year price/earnings ratio especially effective. Value factors worked particularly well on insurance companies and commercial banks.

Among commercial banks, attractive value plays include Citizens Financial ($33; CFG) and Zions Bancorp ($44; ZION). A top pick among insurers, First American Financial ($49; FAF) is from our sister publication Upside.

• Financial Strength factors, including variables comparing cash flow to interest expense or total debt, have worked on stocks in the capital-markets sector, which includes Upside picks Apollo Global Management ($29; APO) and Evercore ($75; EVR). In thrifts & mortgage finance, Momentum variables were effective, with earnings revisions for the current quarter and next quarter among the best. On this theme, Upside recommendations Charter Financial ($16; CHFN) and Walker & Dunlop ($47, WD) boast solid Momentum scores.

The table below lists 10 high-potential financial stocks, with all but J.P. Morgan Chase ($91; JPM) scoring above 90 for Quadrix Overall. The 10 stocks have an average Value score of 83. Four standouts are reviewed below.

Capital markets

With a stock-market value of $3.4 billion and dividend yield of 1.8%, Evercore Partners ($75; EVR) offers investment-banking and money-management services. Although the volume of global mergers and acquisitions has slipped 3% this year, according to The Wall Street Journal, boutique investment banks like Evercore are gaining market share. The number of smaller U.S. deals, a focus for these banks, has held steady in 2017, while deals valued at more than $5 billion have fallen by a third.

Evercore says its advisory revenue surged 32% to $1.25 billion in the 12 months ended June, pushing its market share to about 7%, up from 5% in the prior 12-month period.

Undue caution already appears to be baked into the stock price. Shares trade at 15 times estimated 2017 profits, a 20% discount to their three-year median. Less than 10% of stocks in our research universe trade at steeper discounts to their own three-year norms. Better yet, this particular Quadrix factor tends to work especially well for companies in the capital-markets group. Evercore is a Best Buy in our sister publication Upside, which focuses on smaller stocks.


Commercial banks

Citizens Financial's ($33; CFG) operating momentum is benefiting from rising interest rates and improved commercial activity. Revenue has climbed in 11 straight quarters, with growth totaling 13% for the 12 months ended June. The bank's operating profit margin has expanded in five consecutive quarters, and its return on equity has also steadily marched higher. Despite its strong growth, Citizens trades more than 10% below the median S&P 1500 regional bank relative to trailing earnings, sales, and book value.

The stock is a standout in Quadrix, earning an Overall rank of 98 and scoring above 80 for Momentum, Value, Financial Strength, and Earnings Estimates. It also scores above 85 in Quadrix for both gross margin and earnings before interest and taxes (EBIT) margin, two of the most effective factors for commercial banks. Citizens, yielding 2.2%, is a Focus List Buy and a Long-Term Buy.


Insurance

First American Financial ($49; FAF) provides home-warranty insurance, along with investment-advisory and banking services. It has a 27% share of the U.S. title-insurance market, second-largest in the U.S. One of the larger stocks recommended by our sister publication Upside, First American has a stock-market value of $5.5 billion. In the 12 months ended June, per-share profits rose 17%, revenue 9%, and operating cash flow 9%. Efforts to streamline its operations expanded the insurer's operating profit margin in the June quarter to the highest level for any quarter on record.

Shares trade at 14 times estimated profits for the next 12 months, versus the median of 16 for S&P 1500 property-and-casualty insurers. Yet First American offers a growth profile superior to most of its peers, with per-share profits projected to climb 12% in the coming year, ahead of its industry median of 4% growth. Yielding 3.1%, First American is rated Best Buy in Upside.


Thrifts

Founded in 1937, Walker & Dunlop ($47; WD) is the eighth-largest mortgage servicer in the U.S. Besides originating and servicing loans for multifamily and commercial real estate, Walker offers investment advice and brokerage services. The stock has rallied 52% in 2017, propelling Walker's market value to $1.5 billion. Yet the shares trade at just 10 times trailing earnings, below their five-year median of 11 and industry median of 17. No other S&P 1500 thrift or mortgage company has a P/E ratio below 12.

The company continues to generate outsized growth, with per-share profits, revenue, and operating cash flow surging more than 35% in the 12 months ended June. Growth is expected to slow in the second half of 2017. However, if Walker meets the current consensus profit estimate of $4.50 for 2017 and its trailing P/E ratio merely climbs to 12, then its shares will reach $54 by early next year. Walker & Dunlop is rated Best Buy in Upside.

10 HIGH-POTENTIAL FINANCIAL PLAYS
------------------------------ Quadrix Scores ------------------------------
---- Est. Current Year ----
Company (Price; Ticker)
Momen-
tum
Value
Quality
Fin'l
Str.
Earns.
Ests.
Perfor-
mance
Overall
EPS
($)
Growth
(%)
P/E
Ratio
Industry
Apollo Global Mgmt.
($29; APO)
72
89
76
81
59
93
97
2.46
4
12
Capital
markets
Charter Financial
($16; CHFN)
64
93
81
84
78
27
94
1.16
81
14
Thrifts &
mortgage
Citizens Financial
($33; CFG)
94
90
74
99
81
43
98
2.51
30
13
Commercial
banks
Comerica ($69; CMA)
96
76
78
91
73
58
96
4.67
55
15
Commercial
banks
Evercore ($75; EVR)
78
88
97
66
64
63
98
5.17
20
15
Capital
markets
First American Fin'l
($49; FAF)
88
84
87
72
96
86
99
3.40
16
14
Insurance
J.P. Morgan Chase
($91; JPM)
59
75
69
91
58
72
85
6.68
10
14
Commercial
banks
Primerica ($77; PRI)
77
73
92
70
57
61
93
5.22
15
15
Insurance
Walker & Dunlop
($47; WD)
62
87
97
86
45
78
96
4.50
23
11
Thrifts &
mortgage
Zions Bancorp
($44; ZION)
96
75
69
96
96
69
97
2.78
39
16
Commercial
banks
Note: Quadrix scores are percentile ranks, with 100 the best. Upside stocks in bold.

 


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