U.S. Treasury yields continue to rise, with investors worried about the Fed's next move against a backdrop of elevated inflation and robust economic data. The yield on the 10-year Treasury (V2Y00) is lingering near a new multi-year high of 4.98% today, its loftiest level since 2007.
The uptick in yields follows this week's economic data, featuring stronger than expected reports on both retail sales for September and weekly jobless claims, which just fell to their lowest level since January. The Federal Reserve has hiked interest rates repeatedly since the start of 2022 to reduce the money supply in the economy and rein in inflation - but the labor market remains surprisingly resilient, suggesting interest rates may yet move higher in the near term.
In an interview with CNBC, noted investor Ray Dalio said there's a risk the 10-year Treasury yield could top the closely watched 5% mark. Other high-profile investment moguls, including Larry Fink and Bill Gross, are also calling for 5% yields - making Wall Street extremely nervous, and scrambling to find “safe havens” for their capital in this environment.
Where Should You Invest Amid Rising Bond Yields?
When interest rates rise, the cost of debt increases for individuals and corporations alike. That's because of higher interest expenses - which narrows the profit margins for companies. Comparatively, for individuals, it lowers consumer spending, while driving down demand for auto, mortgage, and personal loans.
In light of this, it's easy to see why the stock market sell-off in 2022 coincided with the start of the Fed's rate hike campaign, and drove down valuations of companies across sectors - particularly growth names that are heavily dependent on debt.
Now, with rates still high and bond yields surging, the investment appeal of equities is further diminished as the return on Treasuries soars.
In this market, it's particularly important to identify companies with strong balance sheets, stable cash flows, and low debt levels - all essential to riding out a challenging macro environment. Here are three top stocks armed with strong balance sheets you can consider buying as 10-year yields creep closer and closer to 5%.
Berkshire Hathaway
A business conglomerate valued at a market cap of $740 billion, Berkshire Hathaway (BRK.B) operates in multiple sectors, ranging from insurance, retail, transportation, energy, and manufacturing. Its portfolio of brands includes Geico, Dairy Queen, and BNSF Railway, which help Berkshire earn steady cash flows that are used to reinvest in growth projects or buy back shares.
Moreover, Berkshire Hathaway - led by legendary value investor Warren Buffett - has significant equity exposure via a portfolio of stocks that includes Apple (AAPL), Coca-Cola (KO), and American Express (AXP). The portfolio helps Berkshire earn millions of dollars in dividends each year, pushing earnings higher.
Berkshire Hathaway ended Q2 of 2023 with $147.4 billion in cash and cash equivalents, providing the company with the flexibility to invest in undervalued businesses or assets. For instance, during the financial crisis of 2008, Berkshire Hathaway went bottom fishing and invested in struggling bank stocks such as Goldman Sachs (GS).
Priced at 21x forward earnings, Berkshire stock is reasonably priced, and the B shares trade at a discount of 21% to consensus price target estimates.
UnitedHealth Group
Valued at $496.5 billion by market cap, UnitedHealth (UNH) is among the largest companies in the world. It is a U.S.-based insurance giant that is growing at a fast clip, allowing UNH to return over 800% to shareholders in the past decade, after adjusting for dividends.
UnitedHealth continues to gain traction and enter new markets on the back of accretive acquisitions. In early 2023, it acquired LHC Group for $5.4 billion, and bought Change Healthcare for $13 billion in 2022.
These acquisitions should allow United Health to increase earnings between 13% and 16% each year in the upcoming decade. Additionally, the company’s free cash flow totaled $38.2 billion in the last four quarters and continues to grow, enabling it to not only pay down debt, but also support dividend hikes.
UNH currently pays shareholders an annual dividend of $7.06 per share, indicating a yield of 1.32%. These payouts have more than doubled in the last five years and could rise higher, given UNH has a payout ratio of just 30%.
Out of the 20 analysts covering UNH, 16 recommend “strong buy,” two recommend “moderate buy,” and two recommend “hold.” Priced at 21.5x forward earnings, UNH trades at a discount of 7.7% to Wall Street's average price target estimate.
Visa
The final stock on my list is Visa (V), valued at $442.13 billion by market cap. Visa has created massive wealth for shareholders, rising about 408% in the last 10 years and 1,770% since its IPO in 2008.
Visa is a financial behemoth, but it is relatively insulated from credit risk compared to other financial firms of its size, thanks to its business model. It operates a communication network that connects banks all over the world, and charges a fee for this service. Visa enjoys a wide economic moat due to its entrenched position in the payments processing segment, and is poised to increase earnings by 14.2% in the next five years.
Despite its massive size, Visa increased sales from $21.8 billion in fiscal 2020 (ended in June) to $31.8 billion in the last 12 months. In the past decade, Visa has increased revenue by 10.4%, while net income has grown by more than 13% annually. Its asset-light model allows Visa to enjoy free cash flow margins of over 60%, which is quite exceptional.
Visa pays shareholders an annual dividend of $1.80 per share, indicating a yield of 0.76%. These payouts have risen by 20% annually in the last 15 years.
Out of the 24 analysts covering Visa stock, 17 recommend “strong buy,” four recommend “moderate buy,” and three recommend “hold.” Priced at 24.6x forward earnings, Visa stock trades at a discount of 10% to its average target price estimates.
