What are we looking for?
U.S. financial companies with growth potential.
The screen
At the Federal Reserve's final meeting of 2016, the Federal Open Market Committee decided to raise interest rates for only the second time since the market crash of 2008. Now with the U.S. economy looking stronger, combined with President Donald Trump's promises to overhaul taxes and increase spending, the market is now expecting two to three rate hikes this year alone.
Higher interest rates are, in general, bad for equities (cheap financing encourages investment and growth). Higher rates are also bad for dividend stocks, as their income stream becomes less valuable relative to fixed-income investments. Financial companies, however, benefit from higher rates as their core business is earning a spread on their loans above what they pay for deposits. While financial companies tend to pay high dividends, perhaps we can find some that are retaining all of their earnings to reinvest in growth opportunities.
First, to find companies that are retaining all of their earnings, we look for a dividend of less than 0.1 per cent.
Next we make sure the company is effectively reinvesting these retained earnings, and require a minimum return on equity (ROE) of 5.5 per cent.
Finally, to mitigate downside risk, we look for companies with a market cap of at least $2-billion (U.S.) and short interest less than 3 per cent.
More about Thomson Reuters
Thomson Reuters delivers trusted news and intelligent information to more than one billion people in 140 countries every day. Our content, software and technology support the way professionals work in a rapidly changing, ever more complex world. Thomson Reuters Eikon is the platform used by financial and corporate clients to access top research, portfolio analytics, charting and screening for every asset class.
What did we find?
The screen yields eight stocks.
Readers of Report on Business will be familiar with Private Bancorp Inc., which has been targeted for acquisition by Canadian Imperial Bank of Commerce to expand its banking presence south of the border.
The company with the highest ROE is a lesser known entity. Essent Group Ltd., a private mortgage insurer with a licence to operate in all 50 states, is currently rated a "buy" by Deutsche Bank with a price target of $40, 15 per cent higher than its current value. Radian Group Inc., another mortgage insurance provider, is also an interesting case. In addition to insurance coverage, Radian also provides consulting for buyers and sellers of mortgage-related loans and securities.
Hugh Smith, MBA, works in the financial and risk unit of Thomson Reuters and specializes in wealth and asset management.