ETF Teardown: The Best Financial Stocks

Noted for their simplicity and other advantages over mutual funds, exchange-traded funds have become a popular investing tool. ETFs hold a collection of stocks that share certain elements. For instance, investors who believe the recent meltdown in the financial sector presents a great opportunity can turn to Financial Select Sector SPDR, whose top holdings include investment banks Morgan Stanley (NYSE:MS) and Goldman Sachs (NYSE:GS). But because these ETFs invest in a number of stocks, their broad diversity also limits your upside.

Fear not, Fool -- in this edition of "ETF Teardown," we'll use some nifty tools to drill into the best investments in the financial services sector. To help, we'll use Motley Fool CAPS, our tool for screening and ranking stocks and stock pickers.

The power of tags
To help investors quickly locate great stocks, the 5,500 stocks rated in CAPS can be "tagged" with descriptors that group the company with others sharing certain qualities -- "Home Health Care," for example, or "Ethanol Production."

Selecting the Financial Services tag in CAPS gives you a list of 32 companies that trade on American exchanges. This particular collection of investments has fallen hard in the past year, down 33%, while the S&P 500 has dropped by 18%.

To see which companies the CAPS community thinks may offer a great opportunity in a beaten-down sector today, we'll sort a sampling of these businesses by their CAPS rating, from one to the maximum five stars. We'll then examine one company to see who -- from Wall Street to Main Street -- is bullish or bearish on the business, and why.

Getting down to the nitty-gritty
Here are some financial-sector stocks I've gleaned from CAPS today.

Re-grouping at Citi
The downsizing plans that some top financial companies laid out more than a year ago continue today, as Citigroup is shedding 146 positions in its Student Loan unit. Of course, this is a drop in the bucket of the 17,000 positions the company committed to eliminating early in 2007. But Citibank's souring on the student loan business may have long-term ramifications in a couple of ways.

Personally, my first introduction to the wonderful world of debt came from a Citibank credit card pushed on me at my college campus. Citibank enjoyed offering a number of services to students hooked on plastic, like myself. But scaling back student loans may lead young and budding earners to other, more stable financial players. Additionally, the massive layoffs are leaving many recent graduates wondering if a career in financial banking is an attractive route in life.

In the past, investment banking was seen as an exciting and lucrative prospect for motivated graduates. With Citigroup recently announcing a 10% cut -- or 6,500 positions -- from its own worldwide investment banking division, some graduates are left wondering if the 80-hour workweeks would simply lead to a pink slip. In a weird, dog-bites-hand-that-feeds-it sort of way, new graduates' growing distaste for once-lucrative banking jobs may compound the difficulty of paying back student loans taken out through companies like Student Loan, of which Citigroup is the majority shareholder.

Whether as a result of the external credit crisis or of poor judgment internally, Citigroup reported a first-quarter loss of $5.1 billion. With expectations for more pain ahead, Citigroup plans to shed $400 billion to $500 billion of its approximately $2.2 trillion in assets in order to grow revenue by 9% over the next several years. With many investors feeling that more consolidation needs to happen at Citibank, it's no wonder that 42% of the CAPS All-Stars rating the stock anticipate that it will underperform the broader market in the future. Overall, more than 23% of the 5,962 investors rating the company in CAPS are bearish on Citigroup today.

Lead a horse to water ...
Plucking individual stocks from the financial sector is, of course, a high-risk endeavor. Investors should always perform their own due diligence on companies rather than taking a recommendation, as even the best stock pickers will be wrong from time to time.

Do you agree that the financial-services companies have more downside ahead? Or is now a good time to invest in beaten-down financials like Citigroup? Give your own opinion at Motley Fool CAPS.