The 10 Best Financial Stocks for Long-Term Investors

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This list of the best financial stocks is based on the thesis that long-term investment outperformance rests on buying and holding shares in companies that have sustainable competitive advantages in their market niche. The basic investing truisms such as diversification, investing for the long-run, and buying shares at a reasonable valuation continue to apply.

Stock picks

Investment thesis

The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.
— Warren Buffett*

This is a list of outstanding companies in the financial sector, with competitive advantages that should make for a great investment if their stock is purchased at an attractive valuation. It is not a suggestion that they are necessarily great investments at their current stock prices, especially since their stock prices may be very different when you read this than when I wrote it. An investing technique used by famed investor Warren Buffett is to build a list of outstanding companies and then buy their stocks only if they fall to attractive valuations. I recommend you follow a similar strategy.

When filtering financial stocks for this list, I focused on five criteria:

  • A sustainable competitive advantage in the marketplace
  • Quality of corporate governance and management
  • Average return on assets over the past decade, including the financial crisis
  • Average per-share book value growth over the past several years
  • Dividend yield (because growth and dividends are tradeoffs)

The list of the 10 best financial stocks

Click the name of any company on the list to see a chart of its long-term stock performance.

1. MasterCard

MasterCard has the strongest competitive position of any financial company on this list. Along with competitor Visa, MasterCard is one partner in an effective duopoly. As Columbia Business School professor Bruce Greenwald points out, being part of a duopoly is the ideal market position for any company to be in. It ensures solid profits, while still keeping anti-trust regulators at bay.

MasterCard makes money in three different ways. First, it franchises its brand of credit card to 22,000 banks and other financial institutions. Second, it acts as a payments processor and effectively collects a "toll" for each credit card transaction it services. Third, MasterCard provides consulting services to financial institutions and merchants.

Like its leading competitor, Visa, MasterCard is so reliably profitable that the biggest difficulty for investors is buying its stock at an attractive valuation. Visa and MasterCard currently have similarly small dividend yields, but MasterCard has a far higher book-value growth rate. MasterCard also historically has had far higher returns on assets.

The trend towards mobile payments has the potential to either greatly undercut or reinforce MasterCard's business, depending on how the technology is implemented. The current leading mobile payments implementation, Apple Pay, reinforces it.

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , MasterCard is rated 4 stars ("Buy") by S&P, 3 stars by Morningstar, and "Outperform" by Credit Suisse. Check with your brokerage firm for the latest recommendations.

2. T. Rowe Price

T. Rowe Price is the fifth-largest mutual fund company. It specializes in no-load mutual funds and has over $730 billion in assets under management. T. Rowe Price is seeing the greatest growth in its retirement-date mutual funds. The fact that two-thirds of the company's assets under management are retirement related, plus the fact that it has a broad diversity of mutual funds available to customers, causes T. Rowe Price to have a low customer turnover. Low customer turnover reduces costs and increases the firm's profits.

Almost all of T. Rowe Price's current customers are in the United States. The company is pursuing international expansion, which provides plenty of opportunity for future growth.

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , T. Rowe Price is rated 4 stars ("Buy") by S&P, 3 stars by Morningstar, and "Neutral" by Credit Suisse. Check with your brokerage firm for the latest recommendations.

3. Franklin Resources

Franklin Resources, better known as Franklin Templeton Investments, is the fourth largest mutual fund company. It has almost $900 billion in assets under management. Franklin Resources specializes in fixed-income, international stock, and value stock mutual funds. The company's mutual funds have below average expense ratios, which benefit existing customers and attract new ones. Due to its scale, Franklin Resources has one of the highest operating margins in the mutual fund industry.

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Franklin Resources is rated 5 stars ("Strong Buy") by S&P, 4 stars by Morningstar, and "Neutral" by Credit Suisse. Check with your brokerage firm for the latest recommendations.

4. U.S. Bancorp

U.S. Bancorp, headquartered in Minneapolis, Minnesota, and focused on the Midwest, is better known as US Bank. It is America's fifth-largest bank, with almost $400 billion in assets. It is big enough to have economies of scale, but small enough to avoid the stricter regulation imposed on its larger "too big to fail" rivals. It has long been a well-managed bank and was able to avoid the extensive damage the financial crisis did to many of its rivals.

US Bank has five business lines:

  • Treasury and Corporate Support (30% of profits)
  • Consumer and Small Business Banking (24% of profits)
  • Wholesale Banking and Commercial Real Estate (22% of profits)
  • Payment Services (21% of profits)
  • Wealth Management and Securities Services (3% of profits)

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , US Bank is rated 4 stars ("Buy") by S&P, 3 stars by Morningstar, and "Neutral" by Credit Suisse. Check with your brokerage firm for the latest recommendations.

5. Bank of Nova Scotia

The Bank of Nova Scotia, also known as Scotiabank, is Canada's third-largest bank. It has assets equivalent to US$650 billion. It has almost 8 million customers in Canada and about 11.5 million customers internationally, including the Caribbean, Latin America, and Asia. Scotiabank has five business lines:

  • Canadian Banking
  • International Banking
  • Scotia Capital (wholesale banking)
  • Global Wealth Management
  • Insurance

Bank of Nova Scotia's dividend yield is the second-highest on this list.

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Bank of Nova Scotia is rated 4 stars ("Buy") by S&P and 3 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

6. Berkshire Hathaway

Berkshire Hathaway is a massive and diverse company run by America's second-richest man, Warren Buffett. Although Berkshire Hathaway owns a variety of businesses, including the BNSF Railway and Duracell, it is largely an insurance company. Its best-known insurance brand is GEICO. Berkshire Hathaway also owns substantial stakes in Wells Fargo, Coca-Cola, American Express, IBM, Wal-Mart, Exxon Mobil, and US Bancorp, among others. In making acquisitions and buying shares of stock, Berkshire follows Philip Fisher's motto that "the time to sell it is—almost never."

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Berkshire Hathaway is rated 5 stars ("Strong Buy") by S&P and 3 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

7. American Express

American Express plays a distant third in the payments card industry, largely due to higher merchant fees. While Visa and MasterCard operate on a franchise system in which banks issue credit and debit cards to customers, American Express traditionally issues proprietary charge cards to customers directly. Although American Express is less widely accepted than Visa and MasterCard, its cardholders are generally higher-income and higher-spending than average and thus make an attractive clientele for higher-end retailers.

American Express has four business lines:

  • US Card Services (51% of revenues)
  • Global Network & Merchant Services (17% of revenues)
  • International Card Services (16% of revenues)
  • Global Commercial Services (15% of revenues)

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , American Express is rated 4 stars ("Buy") by S&P, 3 stars by Morningstar, and "Underperform" by Credit Suisse. Check with your brokerage firm for the latest recommendations.

8. Progressive

The Progressive Corp. is America's fourth largest automobile insurance company. It primarily focuses on personal auto insurance, which makes up 90% of its business. The other 10% consists of commercial auto insurance, motorcycle insurance, and recreational vehicle insurance. 56% of its policies are written through insurance agents, while 44% are sold direct via the Internet and toll-free phone calls. Progressive has the highest dividend yield of any company on this list.

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Progressive is rated 3 stars ("Hold") by S&P and 3 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

9. Wells Fargo & Company

With $1.5 trillion on its balance sheet, Wells Fargo is America's fourth largest bank by assets (and largest by market capitalization). It attained that position at the height of the 2008 financial crisis when it acquired its insolvent larger rival Wachovia. Wells Fargo (including other banks that later merged into it) was the leading bank behind the formation of MasterCard in 1966.

Wells Fargo is organized into three lines of business:

  • Community Banking
  • Wholesale Banking
  • Wealth, Brokerage, and Retirement

Over at least the past decade, including the financial crisis years, Wells Fargo has consistently had higher returns on assets than its larger competitors.

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Wells Fargo is rated 2 stars ("Sell") by S&P, 3 stars by Morningstar, and "Outperform" by Credit Suisse. Check with your brokerage firm for the latest recommendations.

10. Toronto-Dominion Bank

Toronto-Dominion Bank, branded as TD, is Canada's largest bank by assets, with an equivalent of roughly US$750 billion on its balance sheet. It has been on an acquisition spree for at least a decade, and owns almost half of Internet discount brokerage firm TD Ameritrade.

TD is organized into four business lines:

  • Canadian Personal and Commercial Banking
  • US Personal and Commercial Banking
  • Wholesale Banking
  • Wealth and Insurance

Toronto-Dominion Bank makes it onto this list in large part because of its hefty dividend yield and excellent corporate governance.

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Toronto-Dominion Bank is rated 4 stars ("Buy") by S&P and 3 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

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Bonus: Vanguard Financials ETF

If you want to invest specifically in the financial sector as part of a diversified portfolio, one option that is much easier than researching individual stocks is to invest in a financial sector exchange-traded fund (ETF). The Vanguard Financials ETF is the second largest financial sector exchange-traded fund, but it is more diversified and has a better historical performance than the market leader. ETFs are often recommended over individual stocks because of their diversity. As of this writing, the top ten holdings of the Vanguard Financials ETF are:

  1. Wells Fargo
  2. JPMorgan Chase
  3. Bank of America
  4. Berkshire Hathaway
  5. Citigroup
  6. American Express
  7. U.S. Bancorp
  8. American International Group
  9. Goldman Sachs Group
  10. Simon Property Group

Disclaimer

I cannot predict the future—and neither can anyone else

Predicting which stocks will do well in the future is extremely hard. That's why most mutual fund managers fail to beat the performance of index funds. Generally, I recommend investing in index funds or ETFs over individual stocks. But if you are going to invest in individual stocks, it is safest to invest in companies with sustainable competitive advantages that protect their profits from market competition.

Further reading

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