The Federal Reserve is raising interest rates yet again. But much of this is planned and expected. Higher rates should signal that the Fed remains confident about the economy.
Still, this is the first time the Fed has lifted the Fed funds target rate above 1% since the start of the financial crisis in 2008. The market is taking this stride; the S&P 500 is hitting new highs.
The new worry for investors is this: Has the market gotten ahead of itself? Are stocks and valuations getting too rich? Then there’s the idea that many of the major dividend-paying sectors, likes utilities, will become less attractive with higher rates. As rates climb, the return on less-risky assets like bonds also goes up.
But for savvy investors, the interest rate hike isn’t something to fear, rather, it’s something to embrace. Let’s focus on ways to capitalize from rising rates.
What’s the best place to find still cheap stocks that will be able to use higher rates at a catalyst for growth? That would be the financial sector.
With that in mind, here are the top “rate hike stocks“ to own now:
Top Rate Hike Stocks: Capital One (NYSE: COF)
Capital One is one of the cheapest bank-related stocks around, trading at just 80% of book value and 9 times next year’s earnings estimates. This is the best deal you’ll find among any of the credit-card or payment-processing companies. Discover Financial (NYSE: DFS), American Express (NYSE: AXP) and Visa (NYSE: V) all trade at more than 2.5 times book value.
With a 2% dividend yield, Capital One also offers one of the best income opportunities in the industry. The credit-card company has managed to increase dividend in each of the last four years, and its current dividend payout is just 20% of earnings.
Capital One will do well in an environment of higher rates; it’s grown into one of the top 10 U.S. banks ranked by assets. Higher rates will boost Capital One’s interest income but also boost the rates the company can charge on loans and credit cards. And as mentioned earlier, higher interest rates generally signal that the economy is doing well. That should increase usage and demand for Capital One’s small-business loans and credit cards. That makes Capital One a great rate hike stock to own now.
Top Rate Hike Stocks: Berkshire Hathaway (NYSE: BRK-B)
Warren Buffett’s Berkshire Hathaway has had a solid year. Berkshire shares have gained 20%. The massive conglomerate doesn’t offer a dividend, but it may do so in the near future. With a $423 billion market cap, it’s getting harder and harder for Buffett to find companies to buy that are large enough to make a difference in the Berkshire portfolio.
Buffett hinted at the Berkshire shareholder meeting that he’s considering paying a Berkshire dividend. The worry is that he can’t deploy his rising cash pile, up to $90 billion, fast enough.
Buffett noted that he doesn’t want Berkshire to leave shareholder cash just sitting in the bank. “There’s no way I can come back here three years from now and tell you that we hold $150 billion or so in cash or more and we think we’re doing something brilliant by doing it.”
A dividend for Berkshire could attract an entirely new type shareholder: retirees looking for a steady conglomerate with a world-class dividend.
One of Berkshire’s biggest business is its insurance operations, including Geico and its other insurance subsidiaries. Insurers will do well in an environment of higher interest rates. They’ll be able to collect more money on the float, or the premiums that the insurers invest. Don’t forget that some of Berkshire’s holdings like Wells Fargo (NYSE: WFC) and American Express (NYSE: AXP) will also benefit from higher rates.
Top Rate Hike Stocks: Schwab (NASDAQ: SCHW)
Schwab pays a modest 0.8% dividend yield and is expected to be the fastest-growing brokerage firm in the next five years. Wall Street expects Schwab to grow earnings by an average rate of 20% during that time. Schwab has paid a dividend for decades, but last year was the first time we’ve seen an increase in its dividend since the financial crisis.
Unlike other brokerage firms, Interactive Brokers (NASDAQ: IBKR) included, Schwab is more leveraged to higher interest rates. Schwab is a discount brokerage, but it also has an ever-growing, and largely underrated, banking operation. Nearly half of Schwab’s revenues are generated from interest income. Higher interest rates will be a boon for its interest income.
And with the economy doing better, we should see more investors opening brokerage accounts. With the influx of retirees to the market (thanks to the baby boomer generation) and growing millennial base, Schwab should also see increased trading, meaning higher commission revenue.
The pace at which Fed will raise interest rates is anyone’s guess. However, investors can take some of the guesswork out of monetary policy by investing in companies that will get a boost from higher rates and are well-positioned no matter how the interest-rate climate changes.