NEW YORK (TheStreet) -- The Federal Reserve is expected to raise interest rates this year. Rising interest rates reduce the value of real assets like homes and most stocks. Value declines as interest rates rise because investors can get a higher return on their cash, which makes competing returns from real estate and stocks less attractive by comparison.
While it's true that most stocks see their value reduced by rising interest rates, there are a select group of stocks that actually benefit from rising interest rates. These stocks have large amounts of cash invested in short-term interest-bearing securities. When interest rates rise, they benefit as earnings increase due to rising yields on their short-term cash. Banks, insurance companies, and payroll companies all have large pools of cash that are often invested in short-term debt securities.
Banks benefit from the spread on the interest yield they pay depositors and the interest yield they get from investing depositors money. Insurance companies will see earnings rise from their invested float -- premium revenue that has been collected and is being held until claims come in and the insurance company has to pay out. Payroll companies also have a large float as well as they take prepayments from companies for payroll and hold it until they must pay it out when employee payroll comes due.
This article will explore a dominant bank, payroll company, and insurer -- all of whom stand to benefit from rising interest rates. All three of these companies have long dividend histories which makes them likely to continue to pay rising dividends to shareholders. All three are suitable considerations for a hedge against rising interest rates when building your dividend growth portfolio.
Chubb Corporation sells home, car, business, and supplemental health insurance policies through its network of independent dealers in North and South America, Australia, Europe, and Asia. Though Chubb is a global insurance company, about 75% of its revenue comes from the United States.
Chubb Corporation is among the most stable and conservative insurers. The company has posted a combined ratio under 100% every year since 2002. The combined ratio is calculated as the sum of claims paid and operating expenses divided by premium revenue earned. When the combined ratio is under 100% it means an insurer is writing profitable policies -- something Chubb has done every year since 2002.
The company has 89% of its investments in fixed income securities and 3% in short-term securities for a total of 92% of its investable assets in debt securities. The company's fixed income portfolio has an average maturity of between 4 and 5 years. The relatively short maturity of the company's fixed income portfolio reduces the downside effects of interest rate effects on longer-term bonds. The company's fixed income after-tax yield is just 2.65%. Rising interest rates will push this number significantly higher.
Chubb Corporation is a timely investment. The company is a Dividend Aristocrat and favorite of The 8 Rules of Dividend Investing thanks to its 33 consecutive years of dividend increases, low price-to-earnings ratio of 11.8, and 10% a year compound book-value per share growth over the last decade. In addition, Chubb is a very shareholder-friendly company. The company's stock has a 2.3% dividend yield, and management has repurchased an average of over 6% of shares outstanding a year over the last decade. With stronger cash flows from rising interest rates, share repurchases could actually increase in coming years.
Automatic Data Processing is the largest payroll processor in the U.S. Like Chubb Corporation, Automatic Data Processing is a Dividend Aristocrat thanks to its 40 consecutive years of dividend increases.
Automatic Data Processing has significant growth opportunities from increased regulatory complexity. In 1900, common law was all the regulation businesses had to adhere to. Today, we have the Affordable Care Act, Tax Relief Act, HIRE, CHIPRA, HIPAA, OSHA, and countless other alphabet soup regulations. The increasing regulatory complexity has made compliance and payroll experts like Automatic Data Processing a necessity for most businesses. This is not a criticism of these agencies, but a non-biased look at the changing business landscape. It is very likely that the trend toward greater regulation and increased need for compliance will continue regardless of which of the two parties controls the branches of government. As an industry leader in payroll and compliance, ADP has the most to gain from increased regulatory burden.
Automatic Data Processing currently has a market cap of $40 billion. The company has a float of about $22 billion in client funds that it invests in short and medium term debt securities. This float is why Automatic Data Processing stands to benefit from rising interest rates. In total, the company expects to generate $380 to $390 million in income in fiscal 2015 from interest on its float. This comes to about 25% of the company's total earnings -- a very significant amount. If interest rates were to rise, the company would see a significant uptick in its interest income, resulting in higher earnings=per-share and likely increasing the company's share price.
First Financial Bankshares is a regional bank with a market cap of $1.9 billion. The company operates 62 bank locations in the state of Texas. The company is headquartered in Abilene, Texas and is remarkable for its consistency. First Financial Bankshares has increased earnings-per-share for an amazing 28 consecutive years. The company's 125 year operating history has seen it survive the Great Depression of the 1930s, the deep recession in Texas in the 1980s, and the Great Recession of 2007-to-2009. First Financial Bankshares has rewarded shareholders as it has grown by paying steady or increasing dividends since at least 1988.
First Financial Bankshares' remarkable consistency makes it somewhat more expensive than other banks. The company is trading for a forward price-to-earnings ratio of 17.1 -- while not excessively expensive, the company's stock is certainly not a value play at current levels. First Financial Bankshares currently has a dividend yield of 1.9%, in line with the S&P 500's dividend yield.
The company's strategy is to be the market leader in small Texas towns. First Financial Bankshares has the leading share of deposits in many mid- and small-size Texas towns. Texas has been a great place to operate a bank over the last several years. Only Texas and New York have replaced all the jobs lost during the Great Recession. Additionally, Texas' population has grown by over 20% in the last decade and is now the 2nd most populous state in the United States, behind only California. Growth in Texas has lead to growth in First Financial Bankshares assets. From 2009 through 2014, the company's assets grew to $5.8 billion from $3.3 billion.
About 38% of the company's loans to customers are variable rate loans -- when interest rates rise, these loans interest payments will increase. Additionally, the company will benefit from rising interest rates as the spread on deposit interest paid and deposit interest earned increases. If interest rates rise in 2015, First Financial Bankshares will likely see solid earnings-per-share growth.