With unemployment below 4% and high inflation measures, we could be looking at a period in which the Federal Reserve will raise interest rates. Perhaps more importantly, this week’s minutes from the Federal Reserve’s December meeting showed that officials were considering trimming the Fed’s balance sheet soon, which came faster than expected.
Tighter financial conditions and rising rates may slow the economy too much, but the reason for this new hawkishness is that the economy is running at full steam. If rates rise, but not to the point of tipping the economy into recession, low-priced value and cyclical stocks could continue to outperform in 2022 as they did in the first week.
If value and cyclical stocks continue to shine in a strong economy in 2022, the following three stocks still look like absolute bargains.
Bank of America: Conservative, Interest Rate Sensitive and Buffett’s Favorite
If these were value stocks, it should come as no surprise that a Warren Buffett favorite made it to my list. So why does Buffett love Bank of America (NYSE: BAC) so much, enough to make it his second highest position?
It’s probably a combination of two factors. First, Bank of America pursued a “responsible growth” strategy under CEO Brian Moynihan, using its scale to provide low-risk loans to low-risk consumers and businesses at low rates. Second, it is one of the big US banks that would benefit disproportionately from higher rates.
Bank of America can afford to compete with low rates because an inordinate amount of its funding comes from low-rate deposits. Bank of America has invested hundreds of millions in digital technology and expanded to new cities. This nationwide footprint has allowed it to collect tons of consumer deposits that cost it next to nothing. Most impressively, he did it while keeping operating expenses steady, letting headcount dwindle due to retirements, streamlining the branch footprint and cutting other costs. inherited.
The huge deposit base totaled nearly $2 trillion last quarter, with more than $1 trillion coming from low-yielding consumer deposits, up 15% year-over-year. That gives Bank of America the dry powder to deploy into new loans as interest rates rise. After declining lending throughout the pandemic, lending began to rise again quarter over quarter in the third quarter.
Armed with low-cost deposits and contained operating expenses, higher-interest loans resulting from rising interest rates would ensure that most of this additional revenue would flow directly into the bottom line. Management estimates that a parallel 1% rise in interest rates would yield an additional $7.2 billion in net interest income on the same asset base over the next year. This would represent a 17.2% increase in net interest income over the past 12 months.
When you consider that, Bank of America’s P/E ratio of 14 makes it look like a cheap stock you can still buy today, despite strong recent performance.
Pioneer Natural Resources’ dividend is about to skyrocket
Another conservatively managed, dividend-paying company in a procyclical sector is Pioneer of natural resources (NYSE:PXD). This shale player has distinguished itself by focusing on the highest-margin patch of shale – the Midland Basin of the Permian Shale in Texas. In fact, Pioneer just sold its Delaware Basin assets for $3.25 billion, bolstering its balance sheet to become a “pure” Midland game.
The concentration provides Pioneer with extremely low costs per barrel, ensuring profitability in all but the most extreme oil price scenarios. And for those concerned about climate change, Pioneer’s assets and operations are among the least carbon-intensive oil productions in the world, even below those of the low-intensity U.S. shale play as a whole.
Meanwhile, the company recently employed a variable dividend strategy, in which it will limit production growth to 5% and pay most of its free cash flow in the form of dividends, consisting of a base dividend and a variable dividend based on the amount of cash it generates each quarter.
For the third quarter, Pioneer paid a base dividend of $0.56 and a variable dividend of $3.02. This $3.58 dividend equates to a 7.2% return on today’s share price. Yet even this appetizing yield is set to increase further. Management has just announced a 10% increase in the base dividend to $0.62 per share. Also, Q3 still had a few hedges in place, all of which were sold in Q4. The company’s price per barrel of oil equivalent in the third quarter was just $52.79.
Sure, oil is now hovering around $80, there are hedges, Pioneer’s balance sheet is bolstered by excess cash, and management has already revealed it repurchased $250 million in stock last quarter. Expect Pioneer’s big dividend to grow further and the stock to become a huge cash cow in 2022.
Kulicke & Soffa is the cheapest way to play the semiconductor boom today
Even though high-growth non-profit tech stocks have been hammered lately, “tech commodities” — those in semiconductors — have fared much better. And that’s no surprise; we’re in a semiconductor boom right now, and semiconductor stocks are generally much cheaper than high-priced software stocks.
This is accompanied by a similar boom in demand for equipment that manufactures semiconductors. Kulicke & Soffa (NASDAQ: KLIC) is a leader in advanced packaging machines that connect chips into efficient designs for original equipment manufacturers, helping to improve performance and reliability. With more complex semiconductors and chip combinations needed to achieve 5G, artificial intelligence, the Internet of Things and the metaverse, the intensity of advanced packaging is only increasing.
The same applies to the results of Kulicke & Soffa. Over the past 12 months, revenue has grown 144% and earnings per share have skyrocketed nearly 600% to $5.78, making the current stock about 10 times the earnings of followed.
Yes, Kulicke & Soffa is notorious for being cyclical, but given the ongoing chip shortage, this year’s results should be similar. Additionally, K&S has kept a huge amount of cash on its balance sheet – about $740 million, or $11.60 per share in cash, without any debt. Removing that, the P/E ratio drops to around 8.
Nor is the management resting on its laurels as the leader in wire-tie wrapping machines. CEO Fusen Chen has diversified the company into machines that make mini and micro-LED panels, the prevalence of which is expected to grow as demand for high-end displays takes off. In the last cycle, Kulicke & Soffa did not have this product segment. And just last week, management announced new factory automation software, which customers can use to remotely manage thousands of machines.
Although management has been very conservative with its cash, it just increased the dividend by 21% in October, to a yield of 1.1%, and has also started buying back shares. Kulicke & Soffa remains an inexpensive gem in the exciting semiconductor industry.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.