With reduced regulations and taxes along with strong markets and increased expectations for rising interest rates, it's not surprising that several investment experts have chosen stocks from the financial sector when asked for their favorite investment idea for the year ahead. Here are financial sector ideas from MoneyShow's 35th annual Top Stock Picks report:
Chloe Lutts Jensen, Cabot Dividend Investor
CME Group (CME) -- my aggressive idea for 2018 -- was added to my portfolio back in October for longer-term growth and its track record of dividend increases and large special dividends.
It has been in the news recently because the company just started offering bitcoin futures, allowing speculators to bet on the cryptocurrency's price without owning it.
CME Group owns and operates options, futures and derivatives exchanges, including the world's largest derivatives exchange, the Chicago Mercantile Exchange, where investors can trade contracts based on interest rates, stocks, currencies, commodity prices and more.
Commodity futures were originally designed to allow commodity producers to hedge against price changes, but are now also widely used for speculation, mostly by institutional investors. This steady expansion of the derivatives market has fueled steady growth at CME Group.
Revenues have increased in each of the last five years, by an average of 4% per year. Net income has also increased every year, by an average of 11% per year.
The company has beaten estimates in each of the last four quarters. It has also increased their regular dividend for six years in a row while also bringing their payout ratio down from a high of 66% in 2012 to 51% today.
CME Group also boasts a great chart. Its current uptrend started in June 2016, when it broke out of a long base to the upside. The stock rose 40% over the next 17 months, before surging to new all-time highs amid December's bitcoin mania. While the latest surge will likely be followed by a period of consolidation, longer-term, I expect excellent total returns.
Stephen Biggar, Argus Research
Morgan Stanley (MS) is a diversified global financial securities firm. Its businesses include institutional securities sales and trading, investment banking, retail securities brokerage and institutional asset management.
In our view, Morgan Stanley has made significant progress in lowering its risk profile, strengthening its capital buffers, and reducing earnings volatility.
In particular, the Wealth Management segment, which has a more stable revenue and profit profile, now accounts for nearly 50% of revenues, and risk-weighted assets continue to decline.
Results in this segment have also been helped by the company's focus on high- and ultra-high net worth clients, which are seeing the fastest growth.
We expect Morgan Stanley's wealth management franchise to continue to benefit from improvement in the value of financial assets. Meanwhile, growth in compliance costs for Dodd-Frank and other measures has subsided, allowing for margin improvement.
A lighter regulatory environment should also allow for a focus on business-line expansion. Lastly, improving regulatory capital levels should lead to strong increases in the share buyback program and dividends.
In June 2017, Morgan Stanley announced that the Federal Reserve did not object to a 25% increase in the quarterly dividend, to $0.25 per share, beginning in the third quarter. The yield is about 2.0%. We believe that Morgan Stanley will have several more years of above-average dividend increases as capital levels improve.
Chuck Carlson, DRIP Investor
Financials may be my favorite sector for 2018; Regions Financial (RF) , my top pick for aggressive investors, is a large regional bank located in the Southeast.
Rising interest rates should improve net interest margins, and a strong economy should spur loan demand. Regions Financial boosts its total-return prospects via a dividend yield of 2.1%. The stock has done well in recent months but still trades at half the price it sported in 2006, before the financial crisis.
I remain a fan of banking stocks. I like the dividend-growth potential, above-market yields, and ample leverage to an improving economy and higher interest rates. While Regions Financial represents a slightly more aggressive play in the group, I think these shares have the potential to handily beat the broad market.
While I don't expect a move to the $30s over the next 12 months, I wouldn't be surprised to see a move to the lower $20s from the current $17 per share. Regions Financial has a direct-purchase plan whereby any investor may buy the first share and every share directly. Disclosure: I own shares in Regions Financial.
Joe Laszewski, InvesTech Research
Charles Schwab Corp. (SCHW) stands to benefit from today's monetary environment. As short-term interest rates continue to rise, Schwab will earn an incrementally greater net interest margin on its growing pool of interest-earning assets.
With three ¼ ppt interest rate-hikes from the Federal Reserve in 2017, SCHW grew net interest income by nearly +30%. While this pace of growth may be difficult to maintain, the company is positioned to be a primary benefactor should the Federal Reserve continue normalizing interest rates in 2018.
Independent of the path of interest rates, Schwab offers organic growth prospects that are unparalleled by its peers. The company's client-focused, long-term operating initiatives continue to drive double-digit growth in assets. As a result, SCHW is taking market share from smaller competitors and recently reported its ninth straight quarter of record net revenues.
SCHW currently trades at a P/E ratio of about 25.4 based on fiscal 2018 earnings per share of $2.03. This valuation is justified by the company's premium brand, sterling balance sheet, and impressive growth prospects.
Additionally, Charles Schwab is likely to benefit from recently enacted corporate tax reform. Continued flattening of the yield curve would be a risk to the investment thesis, although less so than for traditional banking institutions.
In a sector dominated by value-oriented investment opportunities, SCHW is a well-managed disruptor and true growth story. Future growth within the industry is likely to be driven by market share gains, and Schwab's business model has the company well-positioned to continue taking share.
Note: Clients and individuals associated with Stack Financial Management hold positions in, and may from time to time make purchases or sales of, this security.
Jim Woods, Successful Investing
One area of the economy poised to continue its recent growth is housing. And though tax reform alters the mortgage interest deduction and property tax deductions that many homebuilders fought, many builders now see the various business incentives in the tax reform law as overshadowing the negatives.
Taking advantage of solid housing market is mortgage insurance and reinsurance provider Essent Group Ltd. (ESNT) . The Bermuda-based firm provides the insurance coverage that largely inoculates lenders by paying them when a borrower defaults on a mortgage.
Insurance premiums are paid by the homeowners, of which many are required to purchase the mortgage insurance policy as a condition of loan approval.
The revenue and earnings per share generated in this business are huge, and the margins are very high (margins were north of 50% in fiscal Q1 and Q2, 2017). The result on Essent's bottom line has been an outstanding three-year earnings per share growth rate of 47%.
The company's growth in 2017 helped vault the shares nearly 38% higher. If we see continued improvement in housing along with improvements in the overall economy in 2018, it could be an even bigger year for Essent shares.
Adrian Day, The Global Analyst
Ares Capital (ARCC) is a business development company (or BDC) lending money to small and mid-sized companies and, like REITs, distributing essentially all of their net income to shareholders.
There is concern that rising interest rates will hurt the sector, but what is important for BDCs is the spread over their cost of capital and the returns they can generate. Ares has about 90% of its outstanding loans with floating rates, so as the Federal Reserve raises interest rates, their returns also go up.
Ares is the largest and one of the most conservative of the BDC sector. It also has among the best returns over the years and yet is one of the cheapest right now. There is a reason. One year ago, Ares completed the purchase of American Capital (ACAS) , the second largest publicly traded BDC. It was a good acquisition, buying the assets at a discount.
But American Capital had a relatively low-yielding portfolio with many equity positions, so Ares had to add on the share count without the revenue. Over the past year, it has been steadily rolling over ACAS's low-yielding assets into the more typical high-yielding BDC loan.
As Ares digests its massive acquisition, we will see confidence in the dividend return, and eventually a return to steady dividend increases and bonus dividends that we saw before the acquisition.
I do not think we should expect an increase in the coming year, but equally, I do not expect a dividend cut. At current prices, the yield is 9.7%, an unheard of yield for a conservative company in today's environment. Grab it while you can.
Crista Huff, Cabot Undervalued Stocks AdvisorCIT Group ( CIT) -- my conservative pick for 2018 -- operates both a bank holding company and a financial holding company that provide financing, leasing and advisory services to small and middle market businesses, consumer markets, and the real estate and railroad industries.
Financial companies occupy the "sweet spot" in America's growing economy. Rising interest rates, lower income tax rates (both corporate and personal) and deregulation all serve to increase banks' revenue and net income.
However, the news gets better. There's bipartisan support in the U.S. Senate to change SIFI rules as they apply to banks with less than $250 billion in assets. SIFI rules are regulations that apply to systemically important financial institutions.
The stock market has not factored in potential SIFI changes, largely due to the slow wheels of change in Washington D.C., partisan bickering and 2018 mid-term elections causing decision-making paralysis.
What these expectations don't take into account is that there's a new and highly unusual administration in Washington D.C. that's pushing for reform. There are also lots of newly-nominated and appointed heads of agencies who will presumably want to make their marks by taking action.
As such, I think the long list of proposed SIFI rule changes is going to see some serious action. And that will directly benefit the profitability of small- and mid-cap financial institutions.
I am confident that CIT Group is well positioned to capitalize on both the growing economy and revised SIFI rules that benefit mid-cap financial institutions. I rate the stock a strong buy.
Doug Hughes, Bank Newsletter
Southern Michigan Bank (SOMC) is a $700 million bank located in Michigan, with 15 locations. The bank has been around since 1871. They have almost, no bad loans, strong management and a book value of $30.00 a share. Banks like this usually get almost 2 times book in a takeout.
They also pay a solid 2.5% cash dividend, and should earn well over $3.00 a share in 2018, so the PE is also very low. In my opinion, this is about as safe a bank stock as you can find in today's stock market. I see almost no downside risk and 55% upside, which makes it a top holding.
No other group than the small banks still has so many names that are still so cheap. I expect that there will be a wave of small bank mergers in 2018, with many bank stocks having moved up over 50% or more and many not moving at all, this creates miss-pricing so deals will happen fast.
SOMC fits this merger profile with strong earnings, almost no bad loans, and a stock that hasn't moved up like the larger ones in the group. Fifth Third (FITB) would make a great fit for them; I would view that as a win-win for shareholders on both sides of the deal.
(This column originally appeared at 1 p.m. ET on Real Money, our premium site for active traders. Click here to get great columns like this from Jim Cramer and other writers even earlier in the trading day.)
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