XLF: An X-Cellent Way to Play Financials?

John is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Peruse the picks of America's top value investors and you'll find financial stocks scattered among almost all of the portfolios.  Certainly not in the quantity of the pre-2008 financial crash when financials dominated the value landscape--but financials still attract the value crowd. They're just too cheap to ignore.

But many investors are gun shy, and with good reason.  We've witnessed the severe harm inflicted by just a few trades by a rogue trader, an accounting mess, weak risk management, and the realization that once-in-500-year events seem to happen, oh, every 5 or 10 years.

The Select SPDR XLF ETF seems to uniquely address a real need for those seeking the upside of an undervalued market segment, while also terrified by the single stock risk associated with any of these complex, leveraged companies.

 Diversification, But Big Investments Pack a Punch

The XLF offers investors obvious diversification, while not diluting the impact of an individual investment home run: the top 5 holdings represent 36.5% of the entire portfolio. Lets break that down:

1.) Wells Fargo (NYSE: WFC) 9.02% of ETF:  Wells is often considered the gold standard of American banking. It was started in 1852, surviving a couple of World Wars, deep Depressions, and even the US Civil War! I think it might just make it past the Fiscal Cliff....if its lucky.   Warren Buffett keeps adding to his huge WFC holding, which now totals $14 billion. This makes it about a fifth of Berkshire's stock holdings.   Wells Fargo has increased profitability each year since the financial crisis, has a 12.6% ROE, and pays a 2.7% dividend.  This is what I call the anchor of a financial portfolio.

2.) Berkshire Hathaway (NYSE: BRK-B) 8.60% of ETF:  Not a pure financial pick, but the investment vehicle of Warren Buffett includes companies like GEICO, Property and Casualty Insurers, and Re-Insurers, as well as many financial stock holdings.  I estimate the intrinsic value of Berkshire to be between 27% and  45% higher than the present $88 share price. You'll get a healthy helping of Berkshire stock in this ETF--nearly 9% of the portfolio. To quote Warren Buffett, who quotes Mae West, "Too much a good thing is.....wonderful!"

3.) J.P. Morgan Chase (NYSE: JPM)  8.18% of ETF:  JP Morgan is the largest US bank by assets, and there is a reason why its recently earned that distinction.  While most competitors have struggled to dig themselves out of the financial crisis with earnings nowhere near their peaks, JPM has actually grown earnings an average of 3.24% a year for the past 5 years.  No wonder why Jamie Dimon is an iconic and widely admired CEO.    JPM's financial strength has allowed it to increase its business and consumer lending while aggressively promoting its Chase credit card brand.  Incredibly, JPM's P/E is just over 8 and it sells at a discount to book value. 

4.) Citigroup  (NYSE: C) 5.10% of ETF:  Citi is a controversial big bank bailout survivor that seems to be on a multi-year mission to simply undo everything that Sandy Weill built up. Weighed down by massive bad assets in its Citi Holdings Unit, Citi has just plowed along earning profits from its core operations while shedding non-core assets. Its back to basics plan looks inviting to shareholders, as the big upward move in Citi's stock recently proved when it put its cost cutting mission on steroids: a $1.1 billion cost cutting plan including 11,000 more jobs cuts, another 84 branches shut down, and a pledge to cut expenses to the bone.   At a 54% discount to book value, investors can sit back and wait while shareholder value is attained.   If the stock price doesn't move up, shareholders could push for a break-up

5.) Bank of America (NYSE: BAC) 5.06% of ETF:  CEO Brian Moynihan just gave an upbeat assessment of the bank's key businesses, and the stock soared. Business and Consumer Lending is increasing, Bank Deposits are up, and the Bank's Mortgage Portfolio is riding the wave of a national housing market that sees volumes picking up and prices up nearly 7% year over year.   When your stock is this cheap it doesn't take much good news to get the stock rolling. BAC is selling at a 50% discount to book value.  Its the number 1 player in Global Wealth Management with $2.3 trillion under management.  And analysts believe regulators could allow BAC to finally share some of its excess capital with patient owners. This is the kind of risk/reward that value players love.

The XLF also offers exposure to REITs with holdings that include Simon Property and Boston Properties, exposure to insurance with Allstate and MetLife, credit card companies, including American Express, and even State Street Corporation.

The real appeal for value investors is--you're essentially paying book value for the entire portfolio  (1.02 X book) and a sub market 11.9 times trailing earnings. Investing cheapskates will really like the 0.18% expense ratio.

Think of it this way: if you opened a savings account at any one of these banks, they'd pay you up to 0.5% interest. Buy their stocks via this ETF and they'll pay you 1.8% in dividends while you wait for appreciation.


Grahdodd has long positions in BAC, C, BRKA, and BRKB. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo & Company. Motley Fool newsletter services recommend Berkshire Hathaway and Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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