4 Financial Stocks To Profit From Interest Rate Increases

As the U.S. economy continues to improve, many people watching the stock market expect the Federal Reserve to begin a series of interest rate increases beginning as early as September. Although an environment of increasing rates is generally bad for stocks, it is typically beneficial for the financial services sector.

When rates rise, lenders try to increase the amount they charge for loans faster than what they pay on deposits. This results in an increasing net interest margin, which is good for the lenders' bottom line.

The screen. We used the Recognia® Strategy Builder to search for large U.S. financial services companies poised to benefit from a rising interest rate environment. We began by setting a minimum market capitalization threshold of $10 billion. We wished to focus on the largest and most stable companies in the market, as they offer the greatest security and will be best able to ride out any unfavorable developments in market conditions.

Next, we looked for companies with strong margins and earnings growth as proof of their efficient operations and ability to generate earnings for shareholders. We screened for companies with an earnings-per-share growth rate (projected this year versus last year) of 10 percent or more and a return on equity also of 10 percent or more. Return on equity is a measure of business efficiency that indicates how well the company's management is able to use invested equity in order to create income.

Finally, in order to pick companies with reasonable valuation levels, we specified a forward price-to-earnings ratio of 25 or less. This allowed us to focus on companies whose stocks are reasonably priced compared to their expected earnings. Here are the results:

Bank of Nova Scotia (ticker: BNS) is a Canadian banking giant that trades on the New York Stock Exchange. In addition to being Canada's third-largest bank, Scotiabank also has significant operations in Mexico, the Caribbean and Latin America. Scotiabank passes our screen with a low forward P/E ratio of 11.1 and a projected EPS growth rate this year of 11 percent. The stock has a 4.5 percent dividend yield, making it an attractive option for conservative investors seeking income.

Progressive Corp. (PGR) is one of the largest providers of auto insurance in the U.S. Similar to banks, insurance providers also benefit from a rising interest rate environment because they are required to hold large amounts of debt to underwrite the policies they write. Rising interest rates mean increasing margins and profits for insurance providers. This positive outlook is reflected in Progressive's forecasted EPS growth rate of 23.4 percent and forward P/E ratio of 16.8.

Lincoln National Corp. (LNC) is an insurance and investment management holding company based in Radnor, Pennsylvania. Lincoln National business operations include Lincoln Life and Penn-Pacific Life Insurance. With a forward P/E ratio of just 9.3, the stock looks extremely inexpensive compared to its peers. This is partly the result of the company's second-quarter financial results released on July 29, which missed analysts' expectations on both revenue and earnings, albeit by a small margin. Lincoln Financial is an interesting value play for a patient investor.

American Express Co. (AXP) is a financial conglomerate headquartered in New York. The stock has had a tough run this year, down 21.5 percent year to date. Financial results issued at the end of July were mixed, with the company beating on earnings but missing on revenue. Still, the company has a stellar track record and strong brand recognition around the world. Financial metrics tell a more optimistic story with a 29 percent return on equity and a forward P/E ratio of just 13.6. On Aug. 7, it was announced that hedge fund ValueAct Capital would be taking a $1 billion stake in the company.

Historical performance: Recognia Strategy Builder provides a backtesting capability to evaluate how well an investing strategy would have worked over a five-year historical period. Using a three month buy-and-hold strategy, the screen described had a 14.8 percent annualized return compared to 10.7 percent for the Dow Jones industrial average and 13.4 percent for the S&P 500 index.

The investment ideas presented here are for information only. They do not constitute advice or a recommendation by Recognia Inc. in respect of the investment in financial instruments. Investors should conduct further research before investing.

Peter Ashton of Recognia is a blogger for The Smarter Investor. You can follow him and Recognia on Twitter at @Recognia_Peter and @Recognia.