ETF Teardown: The Best Financial Stocks

Noted for their simplicity and other advantages over mutual funds, exchange-traded funds are a popular investing tool. ETFs hold a collection of stocks that share certain elements, so if investors want to capitalize on the ongoing need for financial services, for example, they can turn to Financial Select Sector SPDR, whose top holdings include American International Group (NYSE:AIG) and JP Morgan Chase (NYSE:JPM).

Investors get a broad diversity since this ETF invests in a number of banking and financial stocks, but this also limits their upside. For an investor who is, say, really hip to companies focused more on consumer credit lending and cold to those heavily exposed to the subprime market, this ETF wouldn't fit the bill.

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

The power of tags
To help investors quickly locate great stocks, any of the 5,100 rated stocks that are profiled in CAPS can be "tagged" with a descriptor that groups the company with others that share a certain quality.

Selecting the "Financial Services" tag in CAPS presents a list of 29 financial investments that trade on American exchanges. To get a sense of which companies the CAPS community thinks are the best opportunities in financial services today -- and which they recommend staying away from -- we can sort this list by CAPS star rank, denoted by one to five stars, with five being the best. Each of the individual companies can then be viewed in terms of exactly who -- from Wall Street to Main Street -- is bullish or bearish on the company and why.

Getting down to the nitty-gritty
Here's a sampling of the financial stocks our screen pulled up today.

Our top listed financial stock in this sweep of CAPS is pawn shop operator and fast-money lender First Cash Financial. With revenues driving north in excess of 22% annually for the last three years and expansion into lucrative markets south of the border, the company gets high marks from investors even though regulators and politicians tend to pooh-pooh the lending practices by First Cash and its ilk. To deal with an often maligned business model that is open to occasional dings from state and federal regulations, First Cash is not only diversifying geographically, but also into other sectors, such as used car sales.

Shares of First Cash have been all over the map in 2007 as the company has been dodging a number of bullets that elicit more "fear factor" than actual damage -- including connection to subprime lending risks in the mortgage market. CAPS investors have remained strong fans of the company through it all, with only 3 of the 413 investors rating the company casting a bearish vote. The company has a fan base of Fool writers as well, with fellow Fool Tom Taulli even calling First Cash his favorite financial stock for 2007.

A financial company that doesn't muster the same enthusiasm is Capital One. Thanks to its high exposure to the consumer credit market at a time when the housing run is "unwinding," investors have been in more of a selling than buying mood for shares of Capital One lately. But the company itself has been a big buyer -- $2.2 billion worth of shares so far this year -- and director Pierre Leroy just recently put up more than six figures to acquire 2,400 shares.

While there may not be blood in the streets just yet, there are at least a few skinned knees and bruised egos gracing the U.S. economy's prominent "Less-Than-Stellar Credit" square. Whether Capital One and one insider are smart to be buying at this point is still not clear, but Capital One appears to be making fundamentally sound business adjustments that will not leave it overextended. CAPS investors are divided on whether the company has the recipe to beat the larger market going forward though, as only 75% of CAPS All-Stars who weighed in have registered bullish votes.

You can lead a horse to water ...
Plucking individual stocks from the financial services sector is, of course, a high-risk endeavor. Investors should always perform their own due diligence on companies rather than taking a recommendation. After all, even the best stock pickers can be horribly wrong.

So, do you believe that consumer financial services stocks are a good investment today? Give your opinion in Motley Fool CAPS.