For now, the Federal Reserve is still calling it “transitory.” But if the high rates of inflation we’ve seen again this month continue into the fall, the central bank may have to change its tune when it comes to its monetary policy. This could mean sooner-than-expected interest rate hikes. In turn, that would be bad news for many growth-oriented stocks that have “crushed it” during the near-zero interest rate environment. Yet, there are some stocks that may see some benefit from rate increases: value stocks.
Particularly those in industries where rising interest rates mean more profits. Think banks, or insurance stocks. There are also stocks in sectors outside of financials that could thrive in a higher interest rate environment.
Well, maybe not due to rising rates, per se. More due to the inflation that caused the rate increases. Primarily, I’m talking about commodity-related stocks, such as oil and gas. Or, consumer products companies with pricing power.
Many of these names have performed well, since the vaccine-fueled recovery and the subsequent cycling back into “old economy” names. But with rising interest rates possibly giving them a further boost, check out these seven value stocks, as names to buy when (or if) the Federal Reserve decides to rein in rising prices:
- Allstate (NYSE:ALL)
- Bank of America (NYSE:BAC)
- Bank of Nova Scotia (NYSE:BNS)
- Chubb (NYSE:CB)
- Altria Group (NYSE:MO)
- Wells Fargo (NYSE:WFC)
- ExxonMobil (NYSE:XOM)
Value Stocks: Allstate (ALL)
Property and casualty (P&C) names like ALL stock stand to benefit greatly from interest rate increases. Why? It comes down to their business model. P&C insurers take the premiums they charge for automobile, homeowners and other types of coverage, and invest the funds until claims are paid out.
Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) has been successful in investing this cash, known as “float,” into stocks. But most insurers invest the bulk of their float into fixed-income assets like bonds. The investment income from investing this float into bonds makes up a small amount of revenues for Allstate ($2.85 billion, versus $39.5 billion in 2020 revenue). Yet, it’s a moderately large amount relative to its net income last year ($5.46 billion).
Admittedly, a rise in interest rates would likely have just a modest impact on Allstate’s earnings. But this isn’t the only reason to buy this value stock. Trading for a forward price-to-earnings (P/E) ratio of 8.4, it sells at a big discount to peers such as Progressive (NYSE:PGR) and Travelers Companies (NYSE:TRV).
The undervaluation of ALL stock is what attracted billionaire investor Carl Icahn to it late last year, when it traded for around $90 per share. So far, Icahn hasn’t employed his usual activist shareholder tactics. Instead, he’s taken a hands-off approach to his investment, as he’s been satisfied with the company’s current shift to a direct-to-customer business model. Shares are up big since he first entered it ($127 per share as of this writing). But with the possible boost from an interest rate hike, coupled with its low valuation and turnaround efforts, there may be opportunity for future gains ahead.
Bank of America (BAC)
Increases in interest rates will have a modest impact on insurance company profitability. For banks? It will have a more dramatic effect. Investors have already bid up BAC stock. Partially due to the “reopening” following the Covid-19 outbreak. Partially due to the anticipation of higher rates, and in turn, higher net interest income as well.
Bank stocks have already seen a big boost to their respective profitability. Largely due to the release of loss reserves, as loan defaults during the pandemic were not as bad as first expected. But a “return to normal” for interest rates, following the “return to normal” for the economy, could result in Bank of America hitting the top end of earnings estimates for the coming year.
Sure, much of this may already be reflected in its share price. At today’s prices, the money center bank trades for around 13.2x forward earnings. Cheap compared to more richly-priced stocks. Yet, it’s not that low compared to its historic valuation. That being said, rising profits from rising interest rates could move the needle in another way: increased dividends and stock buybacks.
The bank has already announced it’s going to raise the BAC stock dividend by 17% beginning this quarter. Also, with its existing $25 billion stock repurchase plan, it can buyback a relatively large chunk of its outstanding share count, which will help boost its earnings per share. The stock may not have room to rally at the level seen during the vaccine recovery (when it soared from around $24 per share, to about $40 per share). However, it may have the potential to deliver solid gains from here, if interest rates climb once again.
Bank of Nova Scotia (BNS)
Best known as Scotiabank, Bank of Nova Scotia is one of the largest financial institutions in Canada. What put its stock on the radar of many investors is its high yield dividend. At current prices (around $63 per share), the stock yields around 4.6%.
Yet, before its late 2020 rally, when shares traded for around $42 per share, this stock was offering up a yield upwards of 7%. So, after getting bid up significantly, is there little reason to dive in today? Not so fast. Even with its run-up, BNS stock sports a low valuation compared to its earnings in the coming year.
Shares today sell for 10.3x projected fiscal 2021 (year ending October 2021) earnings, and 9.9x projected fiscal 2022 (year ending October 2022) earnings. And, that’s assuming the interest rate policy of Canada’s central bank stays as-is until late 2022. As the inflation problem experienced here in the U.S. is happening north of the border as well, The Bank of Canada may have to increase rates sooner than expected.
This would mean higher net interest income, and in turn, higher earnings for BNS stock. The top end of estimates for FY22 call for around $6.70 per share in earnings. Coupled with a likely increase to its dividend payout, this value stock could continue to rise. Even after its 53% surge in the past year.
Value Stocks: Chubb (CB)
CB stock is another name that could see a nice boost to its performance, if interest rate policies change sooner rather than later. Net investment income may have made up only a modest amount of Allstate’s revenue.
But for this Swiss-domiciled insurer, this amount made up a larger share of overall revenues (around 9.4%) last year. Not only that, the total dollar amount of ($3.37 billion) represented nearly all of its 2020 earnings ($3.53 billion). In short, this points to rising rates as having a more dramatic effect on its earnings in the years ahead.
This, however, isn’t the only reason why Chubb may be one of the value stocks to keep an eye on. As InvestorPlace’s Tezcan Gecgil discussed back in January, despite 2020’s many challenges for the insurance industry (civil unrest, natural disasters, the pandemic), the P&C insurer’s underwriting posted solid performance.
So far in 2021, it’s experienced some additional challenges (such as large catastrophe losses related to the winter storms in the U.S. earlier this year). The stock may sport a valuation on par with peers in its industry. Yet, with the potential for its underwriting operations to remain strong, along with rising interest rates, this global insurance and reinsurance provider, which has traded sideways year-to-date, may be a name to consider.
Altria Group (MO)
As I mentioned in the introduction, there are some value stocks that could benefit not directly from rising rates, but from the conditions that create them. That is, stocks set to thrive if the so-called “transitory” inflation winds up being a longer-term issue. Altria Group, parent company of Philip Morris USA, appears to be such a stock.
With this company’s commanding cigarette and smokeless tobacco market share in the U.S., it’ll have a much easier time passing rising prices to consumers. Now, that’s not to say that the company is set to have a blowout quarter anytime soon. Projections call for earnings growth of just 4.8% in 2021. Also, possible changes to tobacco regulation by the Biden administration, coupled with the fallout from its investment in vaping giant Juul mean it’s dealing with many challenges.
Yet, these issues may be more than accounted for in the low valuation of MO stock. At today’s prices (around $47 per share), the stock sports a forward P/E of 10.3x. Not only that, paying out $3.44 per share in annual dividend, it yields a staggering 7.2%. Sure, cigarette smoking is in secular decline. Over time, this may mean an end to its cash cow (cigarette brands like Marlboro), and in turn, a need to cut its payout out of necessity.
However, as I made the case last month, for now Altria is at low risk of a dividend cut. Plus, with the company looking to the future, with new products like the IQOS heated tobacco product, along with its bet on cannabis, via its investment in Cronos Group (NASDAQ:CRON), this controversial value stock remains a great contrarian play that will likely hold up, if high inflation continues.
Wells Fargo (WFC)
Like Bank of America, the possibility of rising interest rates is good news for Wells Fargo. Shares in this money center bank may have staged an epic recovery, after getting hit hard by the onset of Covid-19.
Over the past twelve months, WFC stock has surged more than 70%. Yet, while it has appeared to have topped out since May, catalysts just around the corner may help get back on an upwards trajectory. First, of course, is the rate hike catalyst. A faster move out of today’s still near-zero interest rate environment could help it hit the highest projections for its earnings in 2022 ($4.15 per share).
This could help justify its valuation. A forward P/E of 12x may not sound expensive. But given it is still under the asset cap imposed on it by the Fed due to past scandals, a discount to peers still appears warranted. So, with this big bank with many fleas remaining stuck in the regulatory doghouse, why buy this in lieu of other major banking plays? It plans to return a significant amount of its capital back to shareholders, via dividends and buybacks.
With the go-ahead from the Fed following the most recent round of stress tests, Wells Fargo plans to double its quarterly dividend, as well as buy back $18 billion worth of shares over the next year. This may not result in shares delivering another 70% return over the next year. However, along with the possible boost to the banking industry’s profitability, the stock may have room to add to its gains.
Value Stocks: Exxon Mobil (XOM)
Again, XOM stock is a name that won’t benefit from rising rates directly. But, if we’re still in an environment that results in a need for rising rates, shares in the oil and gas giant, hard hit by the pandemic, could be one of the best value stocks to own.
Why? If today’s inflation winds up not being transitory, oil prices may have even more room to run. At $75 per barrel today, more and more experts are starting to make the case why a move to $100+ per barrel may be possible. This of course bodes well for its earnings recovery.
The oil giant lost $5.25 per share in 2020. Analyst consensus calls for earnings per share (EPS) of $3.77 this year, and $4.44 in 2022. Yet, if oil gets to triple-digit prices per barrel? The recovery could be even more dramatic. In turn, this further bolsters the chances its high dividend (5.7% yield), which was once at feared to be at risk of getting cut, grows between now and 2025.
As for concerns that recent environmentally focused shareholder activism could affect future performance? InvestorPlace’s Ian Bezek recently made the case why this development won’t stop the XOM stock recovery. Put it all together, and this remains a solid way to play rising rates/rising inflation.
On the date of publication, Thomas Niel held long positions in BNS and MO stock. He did not have (either directly or indirectly) any positions in any other securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Thomas Niel, contributor for InvestorPlace.com, has been writing single-stock analysis for web-based publications since 2016.