When we think of bank stocks in Canada, you generally think of the Big 5, an exclusive financial group the BNS is a part of. Financials have always been considered one of the safest investments out there, famous for stable earnings & substantial dividend distribution - both things that Scotiabank stands out from the rest of its peers in exemplifying. Additionally, we need to consider that BNS, as a bank in Canada, has government support & stable deposits built into it, allowing for predictable cash flows, and income generation.
When we look at the current outlook for bank stocks - they provide the best bellwether for the current fears plaguing the market. If the broader economy recovers, that means more customers willing & available to use bank products, less defaults… However, with the current fears of inflation & rising interest rates, financials are the best place to park your money. Rising interest rates lead to an expansion of bank profit margins, as they lend at higher rates. This means that financials are one of the best performing instruments to hedge against rising interest rates, while also keeping open exposure to the long-side of the markets.
Now that we’ve determined that we need some money in the financials, which one is the best? North American Investors are stuck in what are essentially two markets: Canada & U.S. Additionally, BNS provides the best value amongst all of these bank stocks. With expected 2-3% sales growth & a f p/e of under 10, it compares favourably with its competitors.
Bac: 13 f p/e, without even forecasting returning to 2019 revenues
Jpm: 13 f p/e, has returned to 2019, but is forecasting no growth
Ry.to: 12 f p/e, 2-3% growth forecasted
Td.to: 11 f p/e, 2% growth expected
Overall, we can clearly see that BNS is undervalued compared to them all in this market. However, the real crown jewel in all the comps is the dividend yield. BNS offers the highest yield of any of the major bank stocks on the market at near 5%. This difference, sometimes doubling the dividend of other banks, leads to a serious incentive to park your money there.
These discounts can all be attributed to BNS’ involvement in the South American marketplace. This leads to more instability than its competitors, but it also means that they have the potential for serious growth in a developing & unsaturated market.
Finally, we need to talk about the dcf valuation:
With a future growth rate of 2% (including perpetual)
& a required rate of return of 12% (slightly over s&p return, but still enough for a hedging/safe bet)
We arrive at a price of $81-82/share - which gives a margin of safety of 8%
When we factor in the dividend, we approach a potential 17% total return annually on a safe bank stock…
In conclusion, Scotiabank offers an attractive valuation for the industry, and industry leading dividend yield & an overall sufficient safety profile. All of this make it arguably the best financials pick & your best bet to hedge your portfolio against inflation if you want to keep your money in equities.
By: Mateo Gjinali
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