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Financial Services Stocks Look Good Long Term

- Alan Lavine and Gail Liberman

Charles Feinberg, co-manager of the Davis Financial Fund, is optimistic about bank, brokerage and insurance company stocks.

Of course he has a bias. He manages a stock fund that invests in financial services companies. So he wants people to invest. Nevertheless, Feinberg puts his money where his mouth is. Over the past ten years ending in 2003 the fund grew at a 14.64 percent annual rate. After taxes the fund grew at a 13.74 percent annual rate. After taxes and the deduction of an upfront 4.75 percent front end sales charge, the fund grew at a 12.62 percent annual rate.

Financial company earnings are sensitive to rising interest rates. The reason: They make money on their money. So when rates rise, their costs go up. Plus, no one wants to borrow money when interest rates are high. Investors typically flee stocks to higher yield bonds, so brokerage commissions suffer. And insurance companies must pay more interest income to policyholders.

Long term Feinberg is optimistic. Stock prices are relatively cheap in relation to future earnings.

"One reason we like financial stocks for the long-term is that financial services is a vast industry that is not very well understood," he says. "In addition, many companies tend to be under managed overall.

The fund has large stakes insurers such as Progressive and the American International Group. Feinberg says these two companies have "great management teams." The firms can take advantages of their weaker competitors by continuously gaining profitable market share.

The fund also owns H&R Block and Commerce Bancorp. He says H&R Block is a well run company that dominates the tax preparation business. The company has a fast growing sub prime mortgage business. Meanwhile Commerce Bancorp is a fast growing regional bank in New Jersey, New York and Pennsylvania. The bank focuses on service and is open 7 days per week. Core bank deposits are growing rapidly.

The funds largest holdings include American Express, Citigroup, Golden West Financial, D&B, and Everest Reinsurance Group.

Of course there is no free lunch with financial stocks. Risk from terrorism and rapidly rising interest rates could hurt financial stocks. An economic downturn could be damaging. In addition, the companies could have good earnings and strong finances, but their stock prices don't go up.


Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books). Al and Gail's new book is Rags to Retirement, (Alpha Books).

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