Who’s Buying High-Yielding Canadian Banks?

This article was co-produced with Cappuccino Finance.

Every investor has a different definition of their “best” stock. Some prefer a growth stock with high potential of stock price appreciating, while others prefer a stable stock with predictable dividend payments.

For me, dream stocks are the ones that combine a little bit of both. I love companies that have long track records of dividend payment and substantial stock price appreciation over time.

Typically, these companies have strong economic moats to protect their competitive edge, profitability, and market share.

As you all know, I’ve mastered the art of Intelligent REIT Investing, remember I wrote the book on that topic (The Intelligent REIT Investor Guide). And I’m also writing a new book called REITs For Dummies.

As much as I love REITs, I must always remind readers that it’s important to diversify into other sectors, such as banking.

The big Canadian Banks certainly fall into my type of favorite stocks.

Royal Bank of Canada (RY), Toronto-Dominion (TD), and Scotiabank (BNS) have very well-defined economic moats, long track records of success, and solid stock appreciation over the several decades.

Also, due to market volatility, their valuation is below their historical average, and their dividend yields are above their typical range.

In November, Global Finance released the top 10 safest banks by region, and Royal Bank of Canada, Toronto-Dominion, and Bank of Nova Scotia were ranked as the top 3 in North America. Not only do they deliver superb growth, but they also offer safety. It’s hard to argue against investing in these three banks.

It’s a great time for investors to grab some of their shares. The investment will be worth every penny!

Royal Bank of Canada

Royal Bank of Canada is a diversified financial service company. They operate five segments: Personal & Commercial Banking, Wealth Management, Insurance, Investor & Treasury, and Capital Markets.

Their financial products have been ranked #1 or #2 in key Canadian Banking product categories, and Royal Bank of Canada has been a great investment choice for the past several decades and counting.

Royal Bank of Canada has a very strong balance sheet and capital structure. Their CET1 ratio is 12.6%, and ACL to loans ratio is 50 bps. The liquidity coverage ratio is 125%.

This strong balance sheet allows them to make key acquisitions. One recent example is the acquisition of Brewin Dolphin, the leading wealth management service firm in the U.K. This acquisition will further strengthen the wealth management division of Royal Bank of Canada and should deliver strong growth.

The dividend history of Royal Bank of Canada is very strong. They have paid dividends well over 100 years and running, and the dividend growth rate has been solid (7.40%, 5-year CAGR).

Also, their current P/E ratio of 11.62x is far below their 5-year average of 14.65x. The market volatility has created a rare opportunity to grab their shares, while their dividend yield is above 4%.

Given their strong balance sheet, growth trajectory, and competitive edge, I expect their stock price will revert back to its mean.

Toronto-Dominion

The Toronto-Dominion bank is a diversified financial institution that serves Canadian, U.S, and international customers. They operate through Canadian Personal and Commercial Banking, U.S. Retail, Wealth Management, Insurance, and Wholesale Banking segments.

Their footprint has been growing substantially, and their revenue and profit has followed the same trend. Given their recent acquisition of First Horizon and Cowen, I expect their growth to continue in the future.

Toronto-Dominion had an exceptionally strong year in 2022. Their EPS grew by 23% to $9.47, and their revenue was up 15%. These strong results are a reflection of the margin and volume growth in personal and commercial banking businesses.

The profit and revenue growth contributed to an 8% increase in dividend per share, and the current dividend yield is now 4.26%.

Also, they continue to maintain a strong balance sheet. Toronto-Dominion currently has a negative net debt position (-$118 B), which means that they have more cash than debt.

The market volatility created a great opportunity to grab Toronto-Dominion’s shares at a discounted price. Their current P/E ratio of 9.29x and Price/Book ratio of 1.51x are substantially lower than their historical average.

Scotiabank

The Bank of Nova Scotia, or Scotiabank, is a major bank in Canada that has services in Canada, U.S., Mexico, Peru, Chile, Colombia, the Caribbean and Central America. They operate through Canadian Banking, International Banking, Global Wealth Management, and Global Banking and Markets.

They have been a premier bank for a long time, and their shareholders have been rewarded with strong dividend payment and share buybacks.

Scotiabank continued their strong performance in 2022. Their adjusted EPS grew 8% in 2022, mostly driven by higher revenues and lower PCLs. The strong expense management by the leadership team also played a critical role in these solid results. They recorded an adjusted ROE of 15.6%.

Scotiabank’s Canadian Banking and International Banking led the net income growth and overall performance.

During the latest earnings call, management remarked on the strong performance and diversification of their business. The CEO was very pleased with the adjusted earnings of $10.8 B and the strong 15.6% all-bank ROE, both of which exceeded their medium-term financial targets.

Their common equity Tier 1 capital position is at 11.5%, and they are in a great position to continue supporting their growth plan and returning capital to their shareholders.

Also, Scotiabank was recognized as one of the top 25 World Best Workplaces by Great Place to Work Institution, indicating the strong work force and management.

The dividend of Scotiabank is safe at this point, shown by dividend payout ratio of 50.75%. Also, the bank generated 12.44B of cash from operation. I don’t expect Scotiabank to have any cash problem anytime soon.

Meanwhile, their valuation metrics show that they are undervalued. The current P/E ratio of 8.2x and Price to Book ratio of 1.07x are far below their historical average. Also, they are lower than their peers.

Given the strength of their business and balance sheet, I expect their stock price to find its intrinsic value in the future. The current dividend yield of 6.30% is also hard to pass up.

Risk

As all of us are very aware, the market is continuing to be volatile. Even though inflation is on a downward trend, it’s hard to gauge the rate and magnitude.

Due to this uncertainty, it’s also hard to predict the Federal Reserve’s monetary policy decisions ahead. We all know how much the stock market hates uncertainty.

Additionally, the performance of financial institutions is very sensitive to changes in interest rate. They typically are the first to drop with the news of an upcoming recession, but also the first to come up with the news of recovery.

All three financial institutions have exposure to the real estate market, and a downturn in the real estate market is expected in the short-term.

In the case of a severe downturn, if the mortgage rate default rate increases sharply, the performance of banks will be negatively impacted.

Conclusion

As I mentioned in the introduction, the Canadian major banks are one of my favorite types of investment. They have just about everything I can ask for as an investment vehicle. They have a clear competitive edge against their peers, and they are very profitable.

Also, the three banks have long a track record of success. Royal Bank of Canada, Toronto-Dominion, and Scotiabank have been through multiple economic ups and downs, and they know how to handle the situation.

The combined returns of dividend and stock price appreciation have been great from these three banks, and I expect that to be the case in the future.

Global Finance ranked these as the top three safest banks in North America, which shows that your investment is in good hands. At their current attractive valuations, investing in these banks looks like a great option.

Happy Holidays!