3 Top Financial Stocks to Buy in May

This article was originally posted here

As a general rule, recessions are a bad time to be invested in the financials sector. Ideally, you'd like to wait till the recovery has started and all the asset writedowns and dividend cuts are over. So how should a long-term investor wait out the worst during the coronavirus pandemic? Here are three stocks with limited credit risk, which is what you want to avoid at this part of the cycle.

picture of risk and reward

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The best stock in a beaten-up sector

AGNC Investment Corp. (NASDAQ:AGNC) is a mortgage real estate investment trust (mREIT) that specializes in mortgage-backed securities guaranteed by the U.S. government. Like every other mortgage REIT over the past couple months, AGNC has taken its lumps as margin calls have forced it to deleverage. But while mortgage forbearance is going to be a headache for the banks and those who own servicing, forbearance actually works to AGNC's benefit, as it reduces prepayment risk going forward.

At the end of March, AGNC's tangible net book value per share was $13.62, down almost 23% from the same quarter the year before. The company said on its conference call recently that book value had increased about 8% since, which would bring it to about $14.70 now — giving the stock an 18% discount to book value. AGNC also pays a monthly dividend of $0.12, which was cut from $0.16 before the coronavirus pandemic. That works out to be an 11.7% dividend yield at today's prices.

That's not bad for an mREIT that's already taken its medicine, deleveraged, and cut its dividend. The worst is over.

Fee income can help weather the storm

At the start of a recession, it's usually best to avoid banks, since the credit losses are only beginning. With several large sectors of the economy in trouble today (travel, hospitality, retail, oil), banks are likely to be writing down loans, taking big credit provisions, and booking losses. In this sort of environment, banks that rely heavily on fee income are much more solid bets.

State Street (NYSE:STT) is one of the big trust banks in the U.S. Trust Banks generally perform services, like holding client money and earning a fee on that business. State Street earned 78% of its revenue from fee income last quarter, mainly from institutional custody and clearing services and investment management, via its exchange-traded funds business. Earnings per share increased 37% in the first quarter, largely due to increased deposits and foreign exchange trading revenue. This might be a temporary COVID-19 boost that could reverse. And revenue was down slightly last year due to increased competition.

Still, if you want to own a bank during this tough economic time, the trust banks are probably the safest ones to own. State Street is trading at 11 times expected 2020 earnings and has a 3.7% dividend yield.

Long-term trends can't be ignored

Visa‘s (NYSE:V) ubiquitous payment processing system has taken a hit during the pandemic. The company recently withdrew guidance for the year, due to depressed consumer spending. About 25% of Visa's business is in entertainment, travel, and fuel, which have been hit particularly hard.

Despite COVID-19 issues, however, Visa reported a 7% increase in earnings per share to $1.38 for the second quarter of its fiscal 2020 (January to March). The company did warn that the next couple of quarters would be challenging. Still, Visa has $9.7 billion in cash, and the overall shift to more e-commerce and less consumer cash usage will support the stock.

Visa has been one of the better performers in the financial sector this year, only down 4.5%. Trading at 36 times expected 2020 earnings, this stock isn't necessarily cheap, but sometimes stocks are expensive for a good reason — Visa's leading position in the war on cash should ensure a strong recovery.

For the next quarter or two, credit risk will probably be taboo for investors. It's time to play defense. These stocks will be good options for waiting out the storm.

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