When it comes to investing in stocks, no sector quite compares to financials. This segment of the market is not only the largest, but is also a major bellwether for Wall Street and Main Street. Income investors are advised to keep close tabs on this sector regardless of their exposure.
The following article provides a high-level overview of the financials sector, its composition and dividend-earning potential.
Composition of the Financials Sector
Among the 11 primary sectors tracked by the S&P 500 Index, financials is the largest. As of Nov. 29, 2018, the S&P 500’s financials index had a total market capitalization of $7.16 trillion, accounting for more than 16% of the benchmark’s total. With the exception of information technology, which is valued at $6.85 trillion, no other sector comes close to matching financial services.
As a category, financials are much broader than just bank stocks; they include all firms that provide financial services to commercial and retail customers. The S&P 500 breaks down financials into seven broad categories:
- Capital Markets
- Consumer Finance
- Diversified Financial Services
- Mortgage REITs
- Thrifts and Mortgage Finance
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From the perspective of income investors, Dividend.com has broken down the financials sector into 33 constituent parts. This allows market participants to conduct a more granular analysis of the types of dividend stocks best suited for their portfolio. As the following chart illustrates, financials are a worthwhile pursuit for dividend seekers.
|Industry||Company Count||Industry Dividend Yield|
Closed-End Fund – Equity
Closed-End Fund – Foreign
REIT – Residential
REIT – Diversified
REIT – Healthcare Facilities
Closed-End Fund – Debt
Real Estate Development
REIT – Retail
REIT – Industrial
REIT – Hotel Motel
REIT – Office
Investment Brokerage – Regional
Foreign Money Center Banks
Surety & Title Insurance
Money Center Banks
Foreign Regional Banks
Regional – Pacific Banks
Regional – Midwest Banks
Regional – Mid-Atlantic Banks
Regional – Northeast Banks
Investment Brokerage – National
Property & Casualty Insurance
Regional – Southwest Banks
Accident & Health Insurance
Regional – Southeast Banks
Savings & Loans
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The financials sector earns an average dividend yield of 3.11%, tops among all categories tracked by Dividend.com. By comparison, the average dividend yield for the S&P 500 is currently 1.93%. The large-cap average has seen its average yield decline steadily over the past two years despite the resurgence of a politically driven bull market. In fact, at no point over the past two decades has the S&P 500’s average dividend yield even come close to matching those of bank stocks or the broader financial average.
Piles of excess cash and steady growth since the financial crisis have made large-cap bank stocks especially attractive for dividend-focused portfolios. Real estate investment trusts (REITs), which receive special tax advantages by paying out dividends, are also among the highest-yielding companies.
Among banks, companies like Bank of America Corp (BAC ), BB&T Corp (BBT ) and Wells Fargo & Co (WFC ) offer attractive yields. Canadian banks also offer significantly higher yields than the broader market average, with a few examples being Bank of Nova Scotia (BNS ), Royal Bank of Canada (RY ) and Toronto-Dominion Bank (TD ). Each of these financial institutions yields at least 4.5% annually.
In the United States, financial institutions have also benefited from tax reforms, more relaxed regulations and the gradual rise in interest rates. The Federal Reserve has hiked rates eight times since late 2015 and very few sectors stand to benefit like finance.
High-yielding bank stocks carry new significance in inflationary environments. With annual inflation exceeding the Fed’s 2% target, a portfolio consisting of high-yielding bank stocks could serve as a hedge against price growth.
As such, the advantages of investing in financial stocks can be summarized as follows: safety, certainty and high dividend payouts coupled with a rising interest rate environment.
In terms of disadvantages, bank stocks are heavily influenced by the ability of a bank’s customers to repay loans. If loans go bad, the company’s book value is potentially compromised. And while banks do provide a sense of certainty and hedge against inflation, they are not immune to broader market risks. (If you are afraid that stocks are overvalued, then financials are a huge source of risk given their explosive growth in recent years.)
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The Bottom Line
Our crash course on the financials sector is by no means comprehensive. Study banks carefully and keep close tabs on monetary policy and the broader economy to gauge the health of the sector.
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