Inflation accelerated, notably with an increase of 6.8% in November compared to the previous year. This is the largest year-over-year increase in nearly four decades. The Federal Reserve’s response could boost some dividend-paying stocks.
In order to keep inflation from spiraling out of control, the Fed has announced that the reduction in asset purchases will likely end by March of the new year. It was also announced that a majority of Fed committee members expect interest rates to rise by at least three-quarters of a percent next year. This involves at least two to three rate hikes of 25 basis points in 2022.
Rising interest rates would give financial stocks a boost, particularly in the banking and insurance sectors. Higher interest rates would mean improved net interest income and could fuel a sustained recovery in this sector of the economy.
We believe investors looking to take advantage of this opportunity should focus on high quality industry names, including:
- Aflac (NYSE:AFL)
- Bancshares trade (NASDAQ:CBSH)
- JPMorgan Chase & Co. (NYSE:JPM)
The first is Aflac, a diversified insurance company that sells accident, cancer, short-term disability, life, dental and vision insurance. Just over two-thirds of income comes from Japan, with the rest coming from the United States. The nearly $ 38 billion company generates annual sales of more than $ 22 billion.
Like other insurance companies, Aflac generates profits by writing policies and investing in financial assets. Aflac’s net premium income was over $ 4.3 billion in its most recent quarter and $ 13.2 billion for the first nine months of the year.
Aflac invests its premium in financial assets, such as government or corporate bonds. With interest rates so close to zero, the company doesn’t see much return on its investment. However, with each Fed rate hike, Aflac could start to see additional gains on investment, leading to higher profitability.
The good news is that higher interest rates likely wouldn’t have a direct impact on a company’s ability to see demand for its underwriting business. This would give Aflac a best of both worlds scenario where its insurance products remain in demand while higher interest rates give the company a better return on investment.
Aflac has been in business for over 65 years and has learned to navigate the market regardless of the conditions. This is one of the reasons the company is enjoying nearly four decades of dividend growth. Aflac shares are trading at just over 9 times our expected earnings per share of $ 6.10 for the year. The stock also returns 2.9%, which is three times the average return on the stock. S&P 500 Index.
Bancshares Trade (CBSH)
Commerce Bancshares is a banking holding company for Commerce Bank that provides a variety of services, including retail banking and mortgage services. The company also offers asset management, business, investment and trust products. The company is valued at $ 8.3 billion and has annual sales of $ 1.35 billion.
As with other banks, Commerce Bancshares’ growth from interest income was hampered due to near zero interest rates for an extended period.
Yet the company has recently seen small improvements in this area. Net interest income improved nearly 3% year-on-year in the last quarter as Commerce Bancshares saw an increase in income earned on investment securities. This was offset slightly by lower interest charges on loans and securities acquired under resale agreements. As a result, the net return on productive assets fell by 2 basis points to 2.58%.
On a sequential basis, net interest income declined nearly 1% due to lower average loan balances. However, Commerce Bancshares has seen strength in business and construction loans as the economy continues to recover from the Covid-19 pandemic. If the recovery continues, the company should continue to see improved demand for loans in these areas.
Higher interest rates would likely allow Commerce Bancshares to achieve higher growth in net interest income. Rate hikes would likely mean an increase in mortgage rates, but not to the point where demand suddenly ceases. In fact, home sales continue to be strong as unemployment is lower than it has been for some time and supply remains below demand. This would allow Commerce Bancshares to post higher average returns on its loan portfolio while benefiting from increasing income on investment securities.
Commerce Bancshares has one of the longest dividend growth streaks in the market at 53 years, making the company one of the 35 Dividend Kings. The shares are returning 1.6% and the share is valued at 15.3 times our expected earnings per share of $ 4.40 for 2021.
With a market capitalization of $ 463 billion, JPMorgan is not only one of the largest banks in the world, it is also one of the largest corporations. The company has nearly 4,900 branches and provides nearly all possible financial services, including personal and business banking, mortgages, credit cards, asset management and investment banking services. The company achieved nearly $ 120 billion in revenue in 2020.
In the latest earnings call, executives said the forecast for net interest income was around $ 52.5 billion for 2021. It was the same as in the second quarter, but the forecast was reaffirmed before the Fed announced that it was considering a policy change for the coming year.
Net interest income rose 1% to $ 13.2 billion in its most recent quarter, partly due to slightly higher rates from the previous period. A slight increase in net interest income while rates are still low could portend excellent gains in this area over the next two years. JPMorgan is expected to be one of the main beneficiaries of the interest rate hike as the Fed begins to tighten monetary policies.
JPMorgan is also benefiting from an increase in home sales. As a major lender with $ 1,000 billion in loans on average, JPMorgan is of a size and scale unmatched by most of its competitors, which could help avoid considerable weakness if higher rates weigh on demand for ready.
JPMorgan cut its dividend during the Great Recession, but increased it for 11 consecutive years and the stock returns 2.6%. The stocks trade with a price-to-earnings ratio of 10.4 using our estimate of earnings per share of $ 15 for 2021.
The Federal Reserve has forecast that rate hikes will begin earlier than usual, with the majority of committee members expecting three rate hikes in each of the next two years. The financial sector should benefit from this policy change, as interest-bearing investments should start to generate more income.
Aflac, Commerce Bancshares and JPMorgan are three names that we believe will see huge positive winds due to rising interest rates. Each name has a higher dividend yield than the average yield of the S&P 500 Index and trades at a low valuation.
For investors looking to take advantage of higher rates, these three stocks could be attractive options.
As of the publication date, Bob Ciura does not have (directly or indirectly) any position in any of the stocks mentioned in this article. The opinions expressed in this article are those of the author, subject to the InvestorPlace.com Publishing Guidelines.
Bob Ciura worked at Secure dividend since 2016. He oversees all content for Sure Dividend and its partner sites. Prior to joining Sure Dividend, Bob was an independent equity analyst. His articles have been published on major financial websites such as The Motley Fool, Seeking Alpha, Business Insider and more. Bob received a BA in Finance from DePaul University and an MBA with a concentration in Investments from the University of Notre Dame.