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 collections of stocks that share certain elements. If investors think the financial-services sector presents a great opportunity today, for example, they can turn to Financial Select Sector SPDR, whose top holdings include Wells Fargo (NYSE: WFC) and Wachovia (NYSE: WB). But because this ETF invests in a number of companies, its 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 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 locate great stocks quickly, we "tag" CAPS-rated stocks with descriptors that group a company with others in the same category -- "Railroads," for example, or "Teen Clothing."

Selecting the "Financial Data Processing" label in CAPS gives you a list of 13 companies that perform this related financial function. Like many of the larger financial institutions, this particular collection of investments has fallen hard in the past year: While the S&P 500 has ticked down by 6.9%, this group has dropped a full 17%.

To gauge which companies the CAPS community thinks offer good opportunities in this sector today, we'll sort these businesses by their CAPS star rank, from one to the maximum five stars. We'll then examine some of the individual companies to see who -- from Wall Street to Main Street -- is bullish or bearish on the business, and why.

Down to the nitty-gritty
Here are some "Financial Data Processing" stocks I've pulled from CAPS today.

Less taxing growth
As many of the larger financial institutions in the U.S. take their lumps from less-than-forthright lending practices over the past few years, some smaller related companies are taking a similar punishment, even though the guilt by association is sometimes unwarranted.

Financial-management software maker Intuit, for example, has no direct ties to subprime lending or the credit markets. Instead, it gets its momentum from consumers and small businesses in need of its financial and tax software, which will be in demand as long as capitalism and the government exist in the U.S. But the company's business is highly seasonal, and fighting off competition in this sector is quite a chore.

The bulk of Intuit's revenue comes in the fiscal second and third quarters, when tax season hits full stride. Although the dramatically lower revenue and losses that typically characterize the other two quarters may seem unimportant, Intuit has been putting significant efforts into courting small-business owners and startups to help even out product revenue. The company even teamed up with search giant Google to help small companies attract more business with Google applications built into Intuit software.

Unlike the approval rating of the IRS, though, CAPS investors largely have confidence in Intuit's management and prospects for growth. Indeed, 299 of 317 investors rating the company say Intuit will beat the S&P.

Fighting the credit tide
Card issuer American Express, a company more than five times Intuit's size, has similarly learned to profit from small businesses and consumers. The most visible effort in this area is its Open Network, which offers a whole host of products and information around its core card offerings to solve problems for business owners. By offering complete financial solutions, American Express has been able to grow net income by more than 50% over the past five years.

But even with a shareholder-friendly CEO compensation plan, a few more CAPS investors are hedging on American Express these days because of its heavy exposure to the consumer credit market. Some investors see a reduced spending environment as inevitable, particularly as more people lose their homes. Out of the 1,217 investors rating American Express in CAPS, 120 have now voted for shares to underperform the broader market in the future.

You can lead a horse to water ...
Plucking individual stocks from any financial sector is, of course, a high-risk endeavor. Investors should always perform their own due diligence on companies and not just take a recommendation. After all, even the best stock pickers can be horribly wrong on a stock.

So, do you agree that tax software has a profitable future? Or do worries over consumer spending create new buying opportunities? Give your own opinion in Motley Fool CAPS.