As with any sector, you can go about investing in financials in one of two ways: by purchasing sector-specific ETFs, or by investing in individual stocks. On the former front, here’s a pre-defined screen for financial ETFs from useful resource etfdb.com. Note that you have a choice between very broad funds tracking the entire financial sector, such as XLF, and more focused ETFs that invest in a narrower area – such as KBE, which backs only banking stocks.

If you’re interested in investing in individual stocks, then you should now have a good idea of how to analyze banks, investment firms, and diversified financials. Just a quick word on valuation – especially with regard to bank stocks. A company’s price-to-book ratio (P/B ratio) is the relationship between its market value and its “book value” or net asset value – that is, the value of its assets minus its liabilities. P/B ratios are a particularly popular tool for comparing banks because most of their assets (think loans) and liabilities (think deposits) are themselves constantly being revalued at market rates. Put differently, a bank’s book value is a pretty good guide to its market value. That makes P/B ratios a handy way to assess a bank’s valuation relative to those of competitors.

Remember this important detail, though: one of the main drivers of a bank’s P/B ratio is its return on equity (ROE). ROE measures how well a company is using shareholders’ money (a.k.a. equity) to generate profit. It’s calculated as net profit over a certain period (e.g. one year) divided by the average shareholder equity (i.e. book or net asset value) over that period. Banks that can generate higher ROE deserve higher P/B ratios, so take that into account when comparing bank stocks’ valuations.

ROE, by the way, is also a really useful metric for weighing up different investment banking stocks against each other. Since investment banks undertake diverse activities, the easiest way to compare their overall profitability is to find their individual consolidated ROEs. Helpfully, these are always disclosed in the investment bank's financial statements.

So what are you waiting for? Get out there and try these techniques on a few intriguing financial firms – and inject some health into the economy while you’re at it.

In this Pack, you’ve learned:

🔹 The financial sector, made up of banks, investment firms, diversified financial services, and insurance companies, is widely considered to be the lifeblood of the economy.

🔹 Banks make money by pocketing the difference between the interest rates at which they lend and borrow. This is captured in the bank's net interest margin (NIM), which is heavily influenced by the yield curve in the wider economy.

🔹 Assessing a bank's loan portfolio – its growth, composition, and loss provisions – is a crucial step to take before investing.

🔹 Investment firms primarily make money by charging percentage management fees. Such firms’ main revenue drivers are therefore AUM and the weighted-average management fee across all products.

🔹 You can analyze an investment firm by looking at the characteristics of its AUM and how management fees compare to peers’.

🔹 You can invest in the financials sector by purchasing ETFs or by investing in individual stocks. If choosing the latter route, price-to-book ratios provide a useful way to weigh up bank stocks in particular.