This Stock Has A “Hidden” 6.1% Yield (And Rises With Interest Rates)

 | Mar 02, 2021 04:05AM ET

Today we’re going to bulk up our dividends—and position ourselves for some nice gains—with a group of stocks that pay us four ways as interest rates head skyward:

  1. By paying a dividend;
  2. By growing their dividend;
  3. By repurchasing shares, and;
  4. Through the pure profits they “bank” (hint!) as rates rise.

Let’s take that fourth point first, because as you likely know, the 10-year Treasury rate—which drives rates on everything from mortgages to car loans—is en fuego, having surged from 0.9% to more than 1.5% in less than two months.

Granted, a 1.5% Treasury rate would be considered low pre-pandemic. But now it has us choking on our morning coffee!

This is likely just the start.

Fed chair Jay Powell has said flat out that he wants inflation at 2%. This on its own will drive the 10-year rate higher. After all, who would buy a 10-year bond that pays 1.5% when inflation is running at 2%?

Here’s the twist, though: Powell can set the short-term rate, which he has basically anchored to zero.

But on the other end of the curve, he does not control long-term rates. He may say he can influence them by buying Treasury bonds, and to an extent he can, but the bond market is bigger than even his printing press. Over time, Uncle Sam issues more debt than Powell can buy.

That means the “spread” between the long and short end of the interest-rate curve will continue to widen—which leads me back to those “four-way payers” I mentioned off the top.

h2 Rising Rates Set Off a “Dividend Chain Reaction”/h2

The companies we’re going to talk about have their profits dialed straight into the spread: the wider it gets, the more money they make! And you and I both know that where profits go, share prices follow.

These rising-rate winners break out into two groups. The first is bank stocks, which borrow at short-term rates (basically nothing), then loan that cash to customers at rates nearer to the long-term rate (something). The wider that gulf gets, the higher their lending profits go.

The other winners are insurance stocks: as long-term rates rise, these firms benefit because they invest the premiums they collect in, among other things, government and corporate bonds. And yields on those bonds rise with Treasury yields.

Those higher bond yields fatten insurers’ net interest margins, or the difference between investment returns and claims paid out to policyholders. The end result: higher profits—and (very likely) higher share prices to go with them!

Banks and insurers’ higher profits, in turn, fuel the three other ways they pay us, by supporting the current dividend and giving management the cash to grow the payout and buy back shares.

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Repurchases, by the way, touch off another profitable feedback loop because they cut the number of shares outstanding, driving per-share earnings—and by extension share prices—higher.

h3 Forget the Current Yield—Look to Shareholder Yield Instead/h3

Let’s look at all of this in action with a bank we all know well: US Bancorp (NYSE:USB). It yields 3.3% now, which isn’t bad as big banks go. But that’s just the start of what USB pays us, because management also buys back shares on the regular.

You can see that below: in the last 10 years, USB has bought back and canceled 22% of its shares, helping drive the stock to a near-double:

Buybacks Inflate USB’s Share Price