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Where to Invest in a Rising Interest Rate Environment

 

Tuesday, August 29th, 2017

Everyone knows interest rates will be going up. No one knows for sure when it will happen but to stay at these historical low rates much longer would be unprecedented and could cause inflation to spiral out of control in future years. So, what is an investor to do? Definitely do not invest in any type of bond or bond fund. One investment area which benefits from rising interest rates are financial companies such as banks. One financial company that recently caught my attention and is not a bank, per se is a spinoff from General Electric called Synchrony Financial. It trades under the symbol SYF and the company has a market capitalization of over $24 billion. The stock currently trades around $30 per share and has a 52-week high of $38.06 per share and a 52-week low of $26.01 per share.

In April of this year the stock fell 16% in one day because the company set aside a larger amount to cover bad loans. As of June 30th, loan losses totaled $1.3 billion and was up 30% from the previous year. It appears the company is being cautious because they still maintained their full year charge-off forecast of 5%. Synchrony is also looking for strong loan growth due in part to a partnership with Amazon.com. This would mean the company would be collecting more in interest and fees.


So, what are we paying for this company? On an earnings per share basis over the last 12 months the company trades at 11.4 times earnings which is below the industry at 13.7 times earnings. Price to sales also looks attractive at 1.6 which is below the industry at 1.9. And again, these are valuation ratios so you do want to have the number lower than the industry average. Price-to-book value is 1.9 versus 2.1. Out of whack with the other valuation ratios is price to cash flow at 10 versus 4.6. Synchrony does pay a 2% dividend and only uses 19% of their earnings to pay it out to their shareholders who could experience higher dividends down the road.


Year over year the company grew their sales revenue by 12.1%, well above the industry average of 3.1%. Even with the loan write-offs, earnings-per-share year-over-year grew by 1.1% which is far better than the industry decline in earnings-per-share of 6.8%.


Return on equity above 15% always makes me feel good and Synchrony has a return on equity of 15.5% which is far better than the industry average of 11.9%. I was surprised to see a very attractive net profit margin of 14.8% which is better than the industry average at 13.8%. I’m hoping with the new partnership with Amazon they can continue to have a juicy net profit margin.


Looking out to December 2018 the mean of 18 analysts are looking for earnings per share of $3.22. Based on those earnings an investor is only paying 9.4 times forward earnings, not a bad price. Using our average forward PE of 16.5 that would reveal a target sell price of $53 per share for a potential gain of nearly 77%.


Having a financial company in your portfolio could reap you some rewards down the road over the next 12 to 24 months. Patience is a must when it comes to investing but I think the research is well-worth the time to see if this financial company, Synchrony Financial can deliver during the rising interest rate environment.

Do you have a question or a company you would like us to take a look at?
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