Inflation has been surging, including a 6.8% increase in November compared to the prior year. This was the largest year-over-year increase in nearly four decades. The Federal Reserve’s response could boost some dividend stocks.
In order to help keep inflation from spiraling out of control, the Fed announced that tapering of asset purchases would likely end by March of the new year. It was also announced that a majority of Fed committee members expect interest rates to increase by at least three-quarters of a percent next year. This implies at least two to three 25 basis point increase in rates in 2022.
Rising interest rates would provide a lift to financial stocks, especially in the banking and insurance industries. Higher interest rates would mean an improvement in net interest income and could provide fuel for a sustained rally in this area of the economy.
We feel that investors looking to capitalize on this opportunity should focus on the high-quality names in the sector, including:
First up is Aflac, a diversified insurance corporation that sells accident, cancer, short-term disability, life, dental and vision insurance. Slightly more than two-thirds of revenue come from Japan, with the remaining coming from the U.S. The nearly $38 billion company produces annual revenue in excess of $22 billion.
Like other insurance companies, Aflac generates profits from underwriting policies and investing in financial assets. Aflac’s net premium income was more than $4.3 billion during its most recent quarter and $13.2 billion for the first nine months of the year.
Aflac invests its premium into financial assets, such as government or corporate bonds. With interest rates so close to zero, the company isn’t seeing 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 the 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 provide the company with greater investment returns.
Aflac has been in business for more than 65 years and has learned to navigate the market regardless of conditions. It is one reason why the company has nearly four decades of dividend growth. Shares of Aflac trade at just over 9 times our expected earnings-per-share of $6.10 for the year. The stock also yields 2.9%, three times the average yield of the S&P 500 Index.
Commerce Bancshares (CBSH)
Commerce Bancshares is a bank holding company for Commerce Bank that provides a variety of services, including retail and mortgage banking. The company also offers asset management, corporate, investment and trust products. The company is valued at $8.3 billion and has annual revenues of $1.35 billion.
As with other banks, Commerce Bancshares’ growth from interest related income has been held back due to interest rates hovering near zero for an extended period of time.
Still, the company has seen small improvements in this area recently. Net interest income improved nearly 3% year-over-year in the most recent quarter as Commerce Bancshares saw higher earned income on investment securities. Slightly offsetting this was lower interest earned on loans and securities that were acquired under agreements to resell. As a result, the net yield on earning assets fell 2 basis points to 2.58%.
On a sequential basis, net interest income was down close to 1% due to lower average loan balances. However, Commerce Bancshares did see strength in business and construction loans as the economy continues to recovery from the Covid-19 pandemic. If the recovery continues, the company should continue to see an improvement in loan demand from these areas.
Higher interest rates would enable Commerce Bancshares, in all probability, to see higher growth in its net interest income. Rate hikes would likely mean an increase mortgage rates, but not to the point where demand would suddenly cease. In fact, home sales continue to be strong as unemployment is lower than it has been in some time and supply remains below demand. This would allow Commerce Bancshares to see higher average yields on its loan portfolio at the same time it was benefiting from growing income on investment securities.
Commerce Bancshares has one of the longest dividend growth streaks in the market at 53 years, qualifying the company as one of just 35 Dividend Kings. Shares yield 1.6% and the stock is valued at 15.3 times our expected earnings-per-share of $4.40 for 2021.
With a market capitalization of $463 billion, JPMorgan isn’t only one of the largest banks in the world it is also one of the largest companies. The company has close to 4,900 branches and provides nearly every financial service possible, including consumer and commercial banking, mortgage lending, credit cards, asset management and investment banking. The company had revenue of close to $120 billion in 2020.
On the latest earnings call, leadership stated that net interest income guidance was approximately $52.5 billion for 2021. This was the same as the second quarter, but the guidance was reaffirmed before the Fed announced that it was eyeing a policy shift for the coming year.
Net interest income grew 1% to $13.2 billion in its most recent quarter, which was due in part to rates that were up slightly from the prior period. A small increase in net interest income when rates are still low could foreshadow excellent gains in this area over the next two years. JPMorgan should be one of the prime beneficiaries of higher interest rates as the Fed begins to tighten its monetary policies.
JPMorgan also benefits from increased home sales. As a leading lender with $1 trillion in average loans, JPMorgan has a size and scale that is unmatched by most competitors, which could help to prevent considerable weakness if higher rates do pressure loan demand.
JPMorgan did cut its dividend during the Great Recession, but has raised it for 11 consecutive years and the stock yields 2.6%. Shares trade with a price-earnings ratio of 10.4 using our earnings-per-share estimate of $15 for 2021.
The Federal Reserve has forecasted 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 see a benefit from this policy shift as interest earning investments should begin to produce more income.
Aflac, Commerce Bancshares and JPMorgan are three names that we feel will see immense tailwinds from higher interest rates. Each name has a dividend yield greater than the average yield of the S&P 500 Index and trades with a low valuation.
For investors looking to profit from higher rates, these three stocks could be attractive options.
On the date of publication, Bob Ciura did not have (either directly or indirectly) positions in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Bob Ciura has worked at Sure 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 bachelor’s degree in Finance from DePaul University and an MBA with a concentration in investments from the University of Notre Dame.