Federal Reserve Chairman Jerome Powell continues to communicate that the Fed plans to keep interest rates elevated until inflation stabilizes around its 2% annual target. Higher rates often drive lower stock markets, making it tough to find investments that look capable of thriving in what may very well be an extended period of higher-cost borrowing.
Still, the best companies out there are able to thrive, even when money gets more expensive. With that in mind, three Motley Fool contributors went looking for businesses that look capable of winning in a period of higher interest rates. They picked JPMorgan Chase (JPM 0.06%), Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%), and Upstart (UPST 2.76%). Read on to find out why, and decide for yourself whether one or more of them deserve a spot in your portfolio to help you fight through these higher-interest-rate times.
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You can bank on this monster bank
Eric Volkman (JPMorgan Chase): One obvious target sector for taking advantage of meatier interest rates is banking. After all, when interest rates rise, lenders can charge more for their No. 1 product -- loans. Meanwhile, they can keep the interest paid to their depositors extremely low. It isn't hard to push up the profits in such an environment.
And JPMorgan Chase really knows how to capitalize on the situation. Rising rates helped the bank grow its net revenue by a whopping 34% year over year in its second quarter, and headline net income a stupendous 67% skyward.
Yes, the company was helped by the opportunistic acquisition of tottering lender First Republic in May, but even without that big asset, its top line would have expanded by 21%. And profitability would have leaped higher, at almost 40%.
JPMorgan Chase was better prepared than most for the sharp rise in interest rates. Its highly liquid "fortress" balance sheet gives the bank the flexibility to take quick advantage of opportunities -- like, say, the fire sale of a troubled peer such as First Republic.
It also provides plenty of scratch to pay out a relatively generous dividend -- at the moment, the bank's quarterly distribution of $1 per share yields 2.7%. Management has indicated that it will enact a dividend raise, to $1.05. That would bump the yield up to a theoretical 2.8% on the most recent closing share price.
Meanwhile, we can expect more interest rate increases; Federal Reserve officials strongly indicated that the current spate of increases isn't quite at an end. Look for JPMorgan Chase to reap the benefits of this and post more jumps on the top and bottom lines.
When keeping cash pays off in multiple ways
Jason Hall (Berkshire Hathaway): Warren Buffett has for years extolled the virtues of keeping a significant amount of cash on Berkshire's balance sheet. Whether as "bullets" for his "elephant gun" to make acquisitions, or as a margin of safety against catastrophic loss in its insurance operations, Buffett has made sure the company has kept between $30 billion in cash and equivalents and more than $80 billion in cash and short-term treasuries on hand for more than a decade.
Here's the rub: For most of that decade, cash hasn't been a productive asset. With interest rates at 40-year lows for most of that time, the yield that cash earned was actually less than inflation. In other words, Berkshire's money lost spending power the longer it was held. Yet Buffett, along with investing lieutenants Todd Combs and Ted Weschler, are nothing if not disciplined. And the primary purpose of Berkshire's cash is more important than chasing a higher return that may not be as safe as cash or U.S. Treasuries.
But the worm has turned, and Berkshire's penchant for making sure it always had plenty -- maybe excessive -- cash is now favorable. With short-term treasuries now yielding more than 5%, Berkshire's $50 billion in cash and equivalents will kick out over $2.5 billion in interest in a year. With another $100 billion or so in short-term investments that can be rolled over into higher-yield instruments as they mature, Berkshire's cash hoard has now turned into a cash cow of its own, capable of kicking out between $6 billion and $8 billion in cash yield every year, just for running a conservative balance sheet. So now, Berkshire investors benefit from that cash in three ways: as a margin of safety, as dry powder for timely acquisitions, and as a billion-dollar cash generator in its own right now. Talk about putting your cash to work for you.
A company that can better pick out people who will pay back their debts
Chuck Saletta (Upstart): One of the big challenges with higher interest rates is that it makes borrowing money more expensive. That makes it tougher for people to qualify for loans. Say, for instance, you wanted to borrow $30,000 to buy a car. At 2% interest, a five-year loan would cost you around $526 per month. At 8% interest, that same loan would instead cost you around $608 per month.
That extra $82 per month adds nearly 16% to the cost, making the higher-interest-rate loan a tougher one to pay, and thus a tougher one to qualify to get in the first place. That's where Upstart comes into the picture. Upstart uses artificial intelligence to try to figure out who will pay their loans as agreed, even when more traditional lending practices will either reject or penalize those people as higher risks.
By being better able to find those borrowers who will pay but are otherwise shut out of being able to borrow at reasonable rates, Upstart and its lending partners can potentially profit. As higher rates go hand in hand with higher payments and tougher qualification for loans, a larger number of otherwise worthwhile borrowers face the risk of being shut out by traditional lenders.
Rates have risen substantially over the past year, and throughout that time, Upstart indicates that its risk ratings have continued to outperform traditional borrowers' risk profiling methods. That its methods are still showing up well in a tougher overall lending market gives good reason to believe that it really can find good borrowers with otherwise tougher credit scores. And that's why Upstart looks like a potential winner in the high interest rate war.
Businesses that make it through the tough times often can thrive once things improve
At some point, either interest rates will fall or companies will be forced to adapt to the new, higher-for-longer rate conditions they find themselves in. In either case, those that are strongest when times are tough are likely those best able to thrive as conditions stabilize to whatever the new reality looks like. If you think JPMorgan Chase, Berkshire Hathaway, or Upstart is among those best positioned today, then now is a great time to consider whether one or more of them may be a decent fit for your portfolio.
