Fantastic Financials: Davis Advisors on the Industry Today

The financial sector still has room to run, and could be on the cusp of a decade of outperformance, offering exchange traded fund investors a potentially massive growth opportunity ahead.

In the recent webcast, Mispriced Markets? Long-Term Opportunity in Financials, Chris Davis, Portfolio Manager and Chairman, Davis Advisors, explained that Davis Advisors’ management style primarily targets durable businesses with above-average margin returns, strong competitive advantages, and durability.

Following Davis Advisors investment methodology, Davis argued that financials could offer a long-term opportunity for investors. The sector is safer than ever with proven durability, steady compounding machines, attractive valuations, potential underearnings, and attractive dividends and buybacks.

Davis believes that banks look durable with greater capital allocations that have helped limit their downside risks. Over the past year, banks were required to increase capital to hedge against potentially bad loans that would bite back over the course of the coronavirus pandemic. However, these bad loans never materialized, which has left banks with more capital to deploy elsewhere.

Financial sector stocks also show attractive dividends and buyback opportunities. Banks are holding excess capital in the post-coronavirus environment, which can allow the companies to deploy more dividends and buybacks ahead.

The financial sector is seen as a steady compounding machine. The S&P Financial Index has exhibited a 6% 5-year cumulative earnings per share growth since the 1990s.

Looking at valuations, Davis pointed out that financials are attractively priced. The S&P 500 financials sector is the most attractively priced among the various market sectors with a 14.9 forward price-to-earnings ratio. In comparison, the consumer discretionary sector was trading at around a 34.9 forward P/E and the technology sector showed a 25.8 forward P/E. Furthermore, financials relative P/E scores are hovering below their 10-year averages. While financials earnings per share has grown faster than the  S&P 500 index, financial stocks prices continue to fall behind the broader index.

Furthermore, Davis argued that normalizing interest rates would increase financial sector earnings due to the sector’s positive sensitivity to higher interest rates.

While some market observers may warn of risks that are unique to the financial sector, Davis contends that these perceived risks are unlikely to materialize. For example, credit, leverage, interest rate, regulatory, and liquidity risks are not as pertinent as many may believe.

Looking at potential opportunities in the financial sector, Davis highlighted the potential of financial technology, or fintech.

To help investors take a targeted approach to the financial sector, Davis Advisors offers the actively managed Davis Select Financial ETF (NasdaqGM: DFNL), which is backed by a focus on long-term opportunities and incorporates the money managers’ judgment experience, high conviction, low turnover, accountability, and alignment.

DFNL includes a focused portfolio of high-conviction stocks, including a 46.4% tilt toward banks, 35.6% in diversified financials, and 18.0% to insurance companies. The portfolio also focuses on high growth opportunities with high earnings per share growth, along with with attractive valuations or more cheaply priced picks.

Financial advisors who are interested in learning more about opportunities in financials can watch the webcast here on demand.