Think about stocks whose profits grow even as rates rise, Bank of America says

Published Thu, Oct 6 20227:48 PM EDT

In the same way that consumers with savings can benefit from rising interest rates, some companies also stand to gain from the Federal Reserve's push to stamp out inflation, which has resulted in higher Treasury bill yields. These companies are ones that temporarily hold a lot of cash on behalf of customers, receiving premium income from, let's say insurance policies, and paying it out later in the form of claims. In the meantime, those companies get to invest that money at prevailing rates. Income may not have been material when the fed funds rate was zero, but can be significant when three-month Treasury bill yields top 3.3%, where they stand today. Warren Buffett, chairman and CEO of Berkshire Hathaway, which owns the giant auto insurer Geico, has often extolled the virtues of what he calls "float." In one letter to Berkshire shareholders , Buffett explained the attraction of property and casualty insurers like this: "P/C insurers receive premiums upfront and pay claims later. In extreme cases, such as those arising from certain workers' compensation accidents, payments can stretch over many decades. This collect-now, pay-later model leaves P/C companies holding large sums – money we call 'float' – that will eventually go to others. Meanwhile, insurers get to invest this float for their own benefit." Potential float winners Bank of America analysts this week updated the concept by highlighting half a dozen companies that "will benefit from higher rates through improvements in float income." The benefit to those companies' profits ranges from 3% to as high as 20%, the bank estimates, although it says that alone is insufficient to warrant investing in them. Consequently, Bank of America also screened for stocks that are favored by its research teams for other reasons, ignoring banks in favor of "names where lending and investing is not core" to the business model. Among the stocks that turned up on the firm's screen were these: The firm's analysts noted that Charles Schwab in July raised its revenue guidance for 2022. The financial services provider "targets a $350-550 million revenue lift from each additional Fed rate hike on a revenue base of about $21 billion in 2022." HealthEquity , which has owned the flexible spending account manager WageWorks for more than three years, is "well positioned to benefit from a faster Fed hiking cycle in '22," the bank said. Its analysts recently raised their 2023 EBITDA estimate by about 10% as a result of custodial contracts that are typically priced around the end of the year. The stock is higher by about 50% in 2022. For its part, PayPal "stands to benefit from rising interest rates as the company holds significant balances of customer funds stored in PayPal and Venmo," Bank of America wrote. The bank estimates PayPal's float revenue just from holding available-for-sale debt securities and time deposits in customer accounts may have reached $130 million in the third quarter against the second quarter's $53 million, and that annual run rate on this float revenue could surge as high as $520 million. Whatever PayPal's final float revenue, it "should all flow through to operating profit." Progressive Corp. might also applaud the Federal Reserve's higher interest rates. The bank says, the "earnings power of the company's investment portfolio has increased by 30% over the past six months to $313 million pre-tax for the trailing three months ended August 2022." The investment portfolio accounts for about a third of Progressive's operating income. Progressive shares have rallied nearly 20% this year.