Meet the Best-Performing Low-Cost Vanguard ETF in 2024. Here's Why It May Still Be a Buy for 2025 and Beyond.

Mutual fund giant Vanguard Group offers over 60 equity-focused exchange-traded funds (ETFs). There are ETFs for growth stocks, value stocks, and dividend stocks. Some ETFs focus on small-cap shares, while others focus on mega-caps. Some ETFs invest in momentum and others are more balanced.

You may think that Vanguard's best-performing ETF in 2024 holds a lot of Nvidia stock, such as the Vanguard Mega Cap Growth ETF, which has a whopping 12.5% weighting in Nvidia. And while that ETF is up a lot on the year -- 31% at the time of this writing -- an even better-performing ETF has been the Vanguard Financials ETF (VFH -0.70%) which invests purely in the financial sector.

That's right, and its top holdings are stodgy blue chip stocks like JPMorgan Chase and Berkshire Hathaway. And yet, the ETF is up some 37% year to date. Here's why the financial sector could still be worth buying now.

Image source: Getty Images.

Meteoric rise

The financial sector had a rocky 2023, driven by the March 2023 banking crisis that saw some small to midsize banks fail and pressure the entire sector. The Vanguard Financials ETF was down 2.9% through the first three quarters of 2023. But in the last quarter, it roared 14.9% higher and carried that momentum into 2024. Since Oct. 1, 2023, the ETF is up a staggering 57.2%.

It's rare to see a traditionally value- and income-driven sector rally this much in a relatively short period of time. But there's reason to believe the rally is justified and could even carry momentum into the new year.

An earnings-driven rally

The financial sector is being driven by earnings growth and valuation expansions. Across the sector, price-to-earnings (P/E) and price-to-book (P/B) ratios have gone from being below their historical levels to being at or above their historical levels. The following table shows the P/E ratios of top payment processors and investment banks -- which are all top 10 holdings in the Vanguard Financials ETF.

Data source: YCharts.

For the most part, the forward P/E ratios of the payment processors are around their historical averages. Still, there has been a noticeable valuation expansion from Goldman Sachs and Morgan Stanley, which have gone from sector laggards to leaders. The new administration could bring lower regulations and encourage more dealmaking, mergers, and acquisitions -- and that could lead to a sustained boom for the investment banking industry.

Here's a look at the P/B ratios of top diversified banks and Warren Buffett-led Berkshire Hathaway.

Data source: YCharts.

All five companies have P/B ratios right around their historical ranges. A year ago, many of these companies traded at a discount to their averages.

In sum, the financial sector was dirt cheap but has since caught up and become more reasonably valued -- but not necessarily overvalued. 2024 was the perfect storm for the financial sector to take off because it was undervalued and entered a period of rapid expansion across multiple industries within the sector.

A good value in an otherwise expensive market

From diversified banks to payment processors, investment banks, asset managers, insurance companies, and financial services companies, the entire financial sector is thriving right now. With the exception of Bank of America, the top 10 holdings in the Vanguard Financials ETF are all within just 3% of their all-time highs.

JPM data by YCharts

Buying a stock or an ETF at an all-time high can feel counterintuitive because it goes against our instincts to buy at a discount. And yet, the sector remains a surprisingly good value. The Vanguard Financials ETF sports a P/E ratio of 18.6 and a dividend yield of 1.7%. For context, the Vanguard S&P 500 ETF -- which mirrors the performance of the S&P 500 -- has a P/E ratio of 30.2 and a yield of 1.3%.

Other traditionally value-oriented and income-producing pockets of the market have also gotten more expensive. The Vanguard Consumer Staples ETF has seen its P/E ratio soar to 28.4 and its yield drop to 2.6%. Even the Vanguard Utilities ETF now yields under 3% and has a P/E ratio of 25.5.

Valuations across virtually every sector have gone up. And since stock prices are outpacing dividend growth rates, sector yields have also fallen. So while the financial sector isn't as cheap as it used to be, it's definitely not overvalued compared to the rest of the market.

The Vanguard Financials ETF remains a balanced buy

With just a 0.1% expense ratio, the Vanguard Financials ETF offers a fairly inexpensive way to invest in the financials sector. This industry is an excellent way to gain exposure to continued economic growth.

But keep in mind that it could also be prone to a sell-off if there is an economic downturn. Credit card companies would be hit hard if transaction volume and frequencies decline. Diversified and investment banks could face declining profits or returns on equity if consumers and companies struggle to afford their expenses or asset values fall.

The cyclical nature of the financial sector and a history of noteworthy crashes are the primary reasons it tends to trade at a discount to the broader market. It's a similar dynamic as the energy sector, where oil and gas companies often sport inexpensive valuations because of their dependence on commodity prices and vulnerability to fluctuations in earnings.

Still, the Vanguard Financials ETF could be a good buy even at an all-time high because it remains a good value, and many companies are delivering record earnings with few signs of slowing down.