To cut interest rates or leave them be? That is the central debate within U.S. monetary policy today.
Will there be a September interest rate cut? Right now, it’s a hotly contested question. As of this writing, real money betting and predictions market Kalshi’s “Fed rate cut by September?” question is sitting at 43% odds in the affirmative.
Economists can make a good case for either a rate cut or standing firm at the current interest rate for the time being. The economy is softening, and unemployment is ticking higher. At the same time, inflation remains higher than the Federal Reserve would like, giving room for more hawkish monetary policy if needed.
At this point, a September interest rate cut is nearly a 50/50 proposition. For investors who believe the Federal Reserve will deliver a rate cut shortly, these are three stocks that will profit.
Realty Income (O)
Realty Income (NYSE:O) is a triple-net REIT. Analysts use the phrase triple net lease to refer to real estate contracts where the tenant instead of the landlord pays for major costs like maintenance and taxes for a property.
The company is focused on properties that are essential in nature, such as pharmacies, grocery stores, industrial and logistics properties and so on. The company wisely divested its office buildings years ago, insulating Realty Income from the current downturn in that part of the commercial real estate market.
Realty Income is known as “The Monthly Dividend Company.” Its monthly dividend should become more appealing as interest rates start to come back down. In particular, Realty Income’s 5.9% dividend yield will stand out as the rates on government bonds and other fixed-income alternatives decline.
More broadly, REITs also benefit from lower interest rates due to the leverage on their balance sheets. Realty Income has more than $20 billion in long-term debt, and even a small reduction in the company’s average interest rate on its obligations would save it a large chunk of cash.
Polaris (PII)
Polaris (NYSE:PII) is a leading maker of snowmobiles and off-road vehicles.
The company prospered during the pandemic. Consumers were looking for fun ways to enjoy themselves in a socially-distanced manner, and Polaris’ vehicles perfectly fit the situation. Revenues jumped over 40% between 2020 and 2023, and profitability also climbed as margins expanded.
However, the period of high inflation and slowing consumer discretionary spending is starting to hit companies like Polaris hard. Analysts are forecasting that Polaris’ revenues will slide 6% this year, with earnings per share falling approximately 14%.
Even so, Polaris shares are still selling for less than 10 times forward earnings. That comes due primarily thanks to PII stock sliding 35% over the past 12 months. That sell-off seems excessive as Polaris’ operating results aren’t in too bad of a decline. In addition, the moment the Federal Reserve starts slashing interest rates, that could lead to a big rebound in discretionary spending such as for off-road vehicles.
Paycom Software (PAYC)
Software stocks are another category of company that should benefit from interest rate cuts.
Many tech companies are quite sensitive to interest rates due to their long-life cash flows. Software is a highly recurring revenue business, and investors can count on software assets throwing off cash for decades to come. As a side effect of this, however, a sharp rise in interest rates can greatly reduce the valuation of the discounted cash flows (DCF) from a software business.
For example, witness Paycom Software (NYSE:PAYC), whose stock has dropped 52% over the past 12 months. Paycom offers cloud-based human capital management (HCM) solutions. That includes things such as applicant tracking, background checks, onboarding, tax management, employee scheduling and so on.
While interest rates and the macroeconomic environment have hit Paycom’s valuation, the underlying business is fine. Indeed, analysts are projecting greater than 10% revenue growth this year, a rather surprising disparity from PAYC stock’s recent performance. The company easily beat estimates last quarter and is now selling at less than 19 times forward earnings.
On the date of publication, Ian Bezek held a long position in PII stock. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.