Quick, think of a stock in the financial sector that you would feel comfortable buying and not selling for the next 25 years.
Got your answer?
I'm guessing you probably couldn't come up with one because a feeling of fear and indigestion likely overwhelmed you. And who could blame you? If I had the image below stuck in my memory from just seven years ago I'd be leery about using the "set it and forget it" mantra to invest in the financial sector as well.
The give and take of financial stocks
The financial sector has certainly witnessed its fair share of ups and downs. It's a predominantly cyclical sector, meaning financials stocks tend to do really well when the U.S. or global economy is growing, and have a hard time boosting profits when the U.S. economy or global economy is shrinking. Because growth cycles are just a normal part of economics, holding a cyclical stock for extremely long periods of time may not be preferable.
But financial sector stocks also offer a number of benefits. There isn't a sector in the stock market that'll offer investors more dividend-paying stocks than the financial sector. Dividends are often the cornerstone of any well-rounded retirement portfolio, as they can give an investor the opportunity to supercharge their returns by reinvesting those dividends back into the same stock. Not to mention regular dividends are generally a sign of a business positioned to survive over the long-term.
Fundamentally the financial sector is also attractive to all types of investors, appealing to value, income, and growth seekers (depending on the stock). Based on the latest data from Thomson Reuters, the forward P/E of S&P 500-based financial sector stocks was a mere 14.1, the second-lowest in the index, behind only telecommunication services at 14 even. Comparatively, most sectors trade at a forward P/E of between 17 and 20. The implication is there's more possible long-term upside to financial sector stocks relative to other sectors.
To be clear, there probably isn't a financial stock that's going to be entirely unaffected by an economic downturn, so if you're looking for this sort of unicorn you won't find it in this sector. However, the risk-versus-reward ratio can be greatly in investors' favor if they're willing to put in a little research.
Three financial stocks you can buy and hold
With that in mind, let's take a closer look at three financial sector stocks you could confidently consider buying right now and holding over the next 25 years.
1. MasterCard (NYSE: MA)
The first financial stock that I believe long-term investors can buy and not touch for a very long time is MasterCard.
To be fair, MasterCard does have some challenges to deal with, including decreased spending activity during global recessions and the threat that alternate payments platforms (ahem, Apple Pay) could one day bypass it as the payment processing middleman.
But these concerns aside, I believe the reward potential for MasterCard is enormous.
To begin with, investors have to remember that MasterCard is purely a payment processing facilitator and not a lender. This means if economic growth turns negative and loan delinquencies rise, it and its peer Visa have absolutely no liability for those delinquent loans. This is a smart way for an investor to de-risk themselves from sharp economic downturns that occur once or twice a decade.
Another important point is that MasterCard's growth potential is seemingly uncapped for at least the next decade, if not beyond. According to its CFO, 85% of global transactions are still being conducted in cash. This represents a sizable expansion opportunity for MasterCard, which still has a relatively small but growing presence in Africa, Asia, and the Middle East.
Lastly, MasterCard's business model is well-protected since the barrier to entry in payment processing is high. Aside from a few major players, it's virtually impossible for any company short of an Apple to enter the payment processing space and forge the number of merchant connections that MasterCard or its peer Visa have developed over decades.
All told, MasterCard has a big opportunity to increase its dividend over time and is already a free cash flow machine. It's a company I'd suggest you can feel comfortable holding for 25 years.
2. Paychex (NASDAQ:PAYX)
Next on the list we have payroll processing company Paychex.
As I noted above, these companies aren't without their own unique risks. For payroll processor Paychex, it suffers when the unemployment rate rises (fewer employees mean fewer paychecks processed), and it delivers lower investment income when the Federal Reserve drops the federal funds target rate in an effort to boost lending and the overall economy.
Yet, like MasterCard, Paychex has a bright future that shouldn't worry long-term investors much at all.
For starters, Paychex is the perfect play on a growing U.S. economy and an increasing population. Even with baby boomers dropping out of the workforce, the sheer number of younger adults that will take their place over the coming decades, compounded with forecasted economic growth across nearly all sectors, should propel Paychex's top- and bottom-lines higher.
Another key point is that lending rates are currently near historic lows and probably only have room to move higher. This is important because businesses front Paychex money to pay their employees, usually a few days in advance of actually cutting those checks. This short but constant holding period allows Paychex to invest in safe short-term assets like CDs, which are interest-rate sensitive -- and it gets to keep the interest earned! Thus, even if interest rates normalize over the next couple of decades Paychex should see a marked improvement in its investment income. Tack this onto Paychex's 3.1% yield which, when reinvested, could deliver a 115% return over 25 years without a single payout increase, and you'll see why I'm so confident in Paychex.
3. Allstate (NYSE:ALL)
Lastly, I'd suggest long-term investors give consideration to one of the most "boring" sectors of the market -- insurance -- and dig deeper into why Allstate could literally put their portfolio in good hands over the next 25 years.
The biggest risk that Allstate, and really any insurer, faces is the unknown catastrophe that's invariably right around the corner. Insurance, by nature, is there to protect people from unexpected losses, be it property, casualty, of even life insurance for a person's family or loved ones. If a large catastrophe hits, or a series of catastrophes (e.g., hurricanes hitting the east coast of the U.S. and damaging homes), it could cause insurers to pay out more than they're bringing in with premiums and newly underwritten policies. Additionally, weak economic environments that necessitate low interest rates to drive turnaround can hurt Allstate, which benefits from rising interest rates.
These worries are well known, but there's plenty of reason to be bullish on Allstate over the long-term as well.
The biggest advantage for insurers is the business model. Insurers can raise premium prices after a catastrophe and use the catastrophe as justification for nationwide increases. In other words, insurers rarely lose money for any extended period of time, because they can simply exercise their pricing power to rebuild their reserves. And insurers can also raise prices in environments where claims are relatively low, while using catastrophes as the justification once again. In this case they're merely front-running inevitable Acts of God.
Similar to Paychex, insurers should also benefit as lending rates normalize over the long-term. Insurers pool their premium money into fixed-income investments like CDs and bonds, which tend to be interest-rate sensitive. Imagine how much investment income Allstate can generate once it's making 2.5%-3% on a CD instead of just 1% or less!
Taking these factors into account, and Allstate's history of steady dividend growth, I'd suggest this is a company you can trust over the long run.
Sean Williams owns shares of Bank of America, but has no material interest in any other companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
The Motley Fool owns shares of, and recommends Apple, MasterCard, Bank of America, and Visa. It also recommends Paychex. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.