Higher Interest Rates and Regulation Change Creating Opportunities in Financial Companies

Over the past year I’ve helped a few clients increase their take home income by showing them how to buy a money market fund or short term treasury bills. From my experience the average American doesn’t understand how to invest short term or liquid (cash) assets. This is understandable since short term treasuries have only recently started to offer an attractive rate. 18 months ago short term rates were <1%. But times have changed and unfortunately the average American usually holds cash in a checking or savings account uninvested. This is great news for the big banks, since they make a spread off the interest they pay you and the interest they can earn on your uninvested cash. That difference is around 4.5% right now. That means a big profit boost for banks at the moment.

I still have some research to do on the banking industry but I do feel comfortable buying Schwab for my active portfolio clients. They have a nice competitive advantage and a great reputation for providing a good service to their clients. Schwab is also fairly valued when looking at historical earnings so I feel we have a margin of safety with this investment, incase interest rates drop again and the profits shrink. Here are some of the fundamentals:

$133b market capitalization

18.47x five year average Net Free Cash Flow (nfcf) or 5.4% earnings yield 

25x ten year average nfcf Or 4% earnings yield

5 year average nfcf = 7.2B

10 year average nfcf = 5.29B

15 year average nfcf = 3.9B

12% ten year NFCF average return on equity.

26B ltd

41b shareholders equity

Shares outstanding have historically gone up, but shouldn’t be dilutive.

Schwab has seen a good earnings growth rate and strong return on equity over the decades. The valuation according to historical cash flows is not super exciting at the moment but the valuation is low when looking at the $18.9b cash produced in 2023. I feel like we have a good margin of safety with this investment and also some upside potential if government interest rates and current profits stay steady.

Allstate has also been added to the clients active portfolio. In January of this year, California allowed auto insurance companies to increase premiums. I know because I use Allstate and saw my monthly insurance bill increase by 30%. So not only does Allstate benefit from the higher interest rate environment they are also able to increase premiums. This is a double benefit to their earnings power, while the company valuation is already attractive from a historical earnings perspective. Here are some of the fundamentals:

$42b market capitalization

historical nfcf:

4b 2023

4.9b 2022

4.8b 2021

5.2b 2020

4.7b 2019

$23.6b total nfcf for last five years. $4.7b five year average.

4.9b 2018

4b 2017

3.7b 2016

3.3b 2015

2.9b 2014

$18.8b total.  $3.76b five year.  $4.24b ten year average.

$26b shareholder equity. $6.6b Ltd and consistent. Premiums growing at 4.7% annually over last 4 years. 13% book value per share growth. Dividend was .18 cents in 1993 compared to a >2$ dividend today.

They are very focused on keeping and growing customers.  Also very focused on tech and investing in marketing, data. Very long track record of profits.

At less than 10x historical nfcf and the possible boost to earnings from higher interest rates and higher premiums, Allstate has a nice margin of safety with a chance for appreciation if the current environment stays consistent.