How to Invest in Financial Stocks: Banks, Insurers and More

The financial sector includes banks, insurers, asset managers, exchanges and payment companies. These businesses work very differently from most companies, so they need their own set of metrics.

What's in the financial sector

• Banks: from giant global banks to small regional lenders. They earn the difference between what they pay depositors and what they charge borrowers, plus fees.
• Insurers: property and casualty, life and reinsurance companies, which earn from premiums and from investing the money they hold.
• Asset managers and brokers: earn fees based on the money they manage or the trading they handle.
• Exchanges and data providers.
• Payment and consumer finance companies: card networks and lenders. Classification of payment networks has changed over time, so check what a sector fund holds.

Why financials are analyzed differently

For a bank, debt and deposits are the raw material of the business, so ratios like debt-to-equity and EBITDA don't mean much. Investors focus on these instead:

• Price-to-book and price-to-tangible-book: banks' assets are mostly loans and securities, so book value is a meaningful anchor.
• Return on equity and return on assets: how profitably the bank uses its capital. High-ROE banks usually deserve higher P/B ratios.
• Net interest margin: the spread between interest earned and interest paid.
• Efficiency ratio: operating expenses as a share of revenue; lower is better.
• Capital ratios, such as the common equity tier 1 (CET1) ratio, which show the cushion against losses.
• Credit quality: non-performing loans and loan-loss provisions.
• Combined ratio for insurers: claims plus expenses divided by premiums. Below 100% means an underwriting profit.

Key risks

• Economic cycles: loan losses rise in recessions.
• Interest rates: they affect lending margins and the value of bonds banks hold. See how interest rates affect stocks.
• Funding runs: banks that rely on uninsured deposits can face sudden withdrawals if confidence falls.
• Leverage: banks operate with high leverage, so small losses on assets can mean large losses for shareholders.
• Catastrophes for insurers, and regulation across the sector.

Ways to invest

Financial sector ETFs such as XLF or VFH offer broad exposure. Many large banks and insurers pay dividends, so check the payout ratio. Filter the Financial Services sector in the stock screener and compare banks with the compare tool, keeping in mind that the general-purpose StockEngine Score isn't designed around bank-specific metrics; see our methodology.

This article is educational and not investment advice.