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The stock market is not performing very well to start 2015. In fact, the Dow Jones Industrial Average and the S&P 500 index are both near even year-to-date. One major reason for investors’ pessimism is the prospect of higher interest rates on the horizon.
Investors appear worried that the Federal Reserve will raise interest rates later this year, which would conceivably raise companies’ costs of capital. Moreover, higher rates would compel investors to sell their stocks, because they could earn higher rates of return from less-risky assets.
This has prompted a wave of articles in the financial media telling investors which stocks to stay away from in times of rising interest rates. While this is worthwhile advice, it’s useful to remember that there is always a bull market somewhere. Indeed, there are definitely companies that would benefit from higher interest rates. Namely, this includes financial stocks.
When investors think of investing in the financial sector, the big banks are usually at the top of the list. But for income investors, the big banks don’t have much to offer. Many, like Bank of America (NYSE: BAC) and Citigroup (NYSE: C), offer tiny dividend yields. For this reason, I would steer income investors to a different financial industry: insurance.
The Beauty of Insurance
Insurance is a great business model. Insurance companies earn income in two ways, by collecting premiums for policies they write, and then by investing their large cash piles. Moreover, insurance companies are not nearly as risky as the big banks. They do not have nearly the same volatility that results from banks’ trading businesses, nor should investors worry about an insurance company absorbing billions in litigation expense.
Insurance is a highly lucrative and steady business, which is why Warren Buffett owns Geico.
Among insurance companies that will benefit from higher interest rates, three of my favorites are Cincinnati Financial (NYSE: CINF), Mercury General (NYSE: MCY) and AFLAC (NYSE: AFL).
Each of these three companies has a long track record of slow-and-steady growth, and each has raised its dividend for many years in a row.
A Dividend Aristocrat
For example, Cincinnati Financial is an S&P 500 Dividend Aristocrat, more than twice over. The company has increased its dividend for an astounding 55 years in a row. The stock offers a 3.6% dividend.
Mercury General is a leading independent broker and agency writer of automobile insurance in California. It’s also a Dividend Aristocrat, as it has increased its dividend for 27 years in a row. mGeneral’s dividend tops this list, at 4.4%.
Aflac offers supplemental insurance, in the United States, and also does a significant amount of business in Japan. Aflac pays a 2.5% dividend, and last year increased its dividend by 5%. This was the 32nd consecutive annual dividend increase for the company.
Not only do these stocks provide excellent dividend yields and annual dividend growth like clockwork, but they are also solidly profitable.
Cincinnati Financial’s net income grew 2% last year, and its book value increased 8% to an all-time high. This was due to strong performance across the company’s core insurance businesses, and also from rising income from its investments. Earned premiums rose 8%, and investment income net of expenses grew nearly 4% for the year.
Mercury General’s premiums written rose 4% last year to $2.8 billion. Also, its after-tax investment income grew 1.7% in 2014. The company’s average annual investment yield dropped by 10 basis points, which reflects the struggle insurance companies have in a low-rate environment. However, this demonstrates that if interest rates were to rise, this metric would improve.
Lastly, Aflac’s earnings per share increased 8% last year. This was due to particularly strong performance in the United States, where sales grew 7% for the year. This year, the company believes its U.S. business will lead the way again, as management expects 3% to 7% sales growth in 2015.
The key takeaway for investors is that insurance stocks are often a better way to invest in financial stocks than the big banks. Insurance companies earn income through both premiums written and on their investment portfolios. This results in a steady stream of profits, which well-run companies like Cincinnati Financial, Mercury General and Aflac return to shareholders through high dividend yields.
Dividends for Every Month of the Year
If you’re looking for just one dividend stock to round out your income stream, consider a little-known company that pays out dividends 12 months of the year.
Click here to see the full details of this company in my Dividend Calendar…