Updated on May 20th, 2019 by Josh Arnold
The largest Canadian banks have proven over the past decade that they not only endure times of economic duress better than their American counterparts, but that they can grow at high rates coming out of a recession as well. The group as a whole also pays very nice dividends, making them attractive for income investors.
Valuations have also remained quite low recently, boosting their respective total return profiles as a result.
In this article, we’ll take a look at four large Canadian banks – The Royal Bank of Canada (RY), The Bank of Nova Scotia (BNS), Bank of Montreal (BMO) and Toronto-Dominion Bank (TD) – and rank them in order of highest prospective total returns.
Note: Canada imposes a 15% dividend withholding tax on US investors. In many cases, investing in Canadian stocks through a US retirement account waives the dividend withholding tax from Canada, but check with your tax preparer or accountant for more on this issue.
The top four big banks in Canada are very shareholder-friendly, with attractive cash returns. All four are on our list of 1,263 dividend-paying stocks from the financial sector. You can download the entire list by clicking the link below:
More information can be found in the Sure Analysis Research Database, which ranks stocks based upon their dividend yield, earnings-per-share growth potential and valuation to compute total returns. The stocks are listed in order below, with #1 being the most attractive for investors today.
Read on to see which Canadian bank is ranked highest in our Sure Analysis Research Database.
Canadian Bank Stock #4: Bank of Montreal
Bank of Montreal was formed in 1817, becoming Canada’s first bank. The past two centuries have seen Bank of Montreal grow into a global powerhouse of financial services and today, it has more than 1,500 branches. Bank of Montreal’s stock has a market capitalization of CAD$66 billion.
In addition to trading on the New York Stock Exchange, Bank of Montreal stock also trades on the Toronto Stock Exchange, as do the other stocks in this article. You can download a database of the companies within the TSX 60 below:
Bank of Montreal’s recent Q1 earnings report was mostly in line with expectations, but the bank continues to perform well. Total revenue gained 6% as weakness in the bank’s market-sensitive businesses was more than offset by strength from its personal and commercial banking segments, both in the US and Canada.
Net income at the US banking unit rose a staggering 42% year-over-year, more than offsetting a decline of 10% from wealth management and a 3% decline from its capital markets business. Market volatility in stocks and other asset classes to close out 2018 took its toll on Bank of Montreal’s results, but it performed very well in light of this significant headwind.
Bank of Montreal’s credit quality remains outstanding, as we can see from this chart from the Q1 earnings presentation. The bank’s loan book was larger year-over-year, but credit losses moved down on both a dollar basis and as a percentage of loans.
Total provisions for credit losses fell from $141 million to $137 million year-over-year as some weakness in credit quality in the Canadian P&C business was more than offset by a very strong performance from the US P&C business. This is one of Bank of Montreal’s attractive features as its lending practices are always top-tier, resulting in strong credit quality.
The bank’s capital position remains strong as well as its common equity tier 1 ratio is 11.4%, essentially flat year-over-year. This is because Bank of Montreal distributes nearly all of its capital that is generated through strong earnings via dividends and share repurchases. Its capital buffer is more than sufficient to weather a downturn and thus, it is free to return new capital to shareholders as it does not need to hold it on the balance sheet.
Adjusted earnings-per-share came in at $2.32 in Q1, a 10% increase over the comparable period last year. We’re reiterating our estimate of $9.55 in earnings-per-share for this year after the in-line Q1 report.
Separately, Bank of Montreal announced it would buy back up to 15 million shares, good for around 2% of the float.
Bank of Montreal’s earnings performance was very stable in the past decade. It has produced higher earnings-per-share every year since 2009 and for this year, we are forecasting earnings-per-share of $9.55, and we expect 4% annual growth thereafter.
We see low single digit revenue growth as the primary driver of earnings-per-share growth moving forward, as well as a low-single-digit tailwind from share buybacks. Further margin expansion will be challenging to achieve, given that the bank’s margins are already very strong, as is credit quality. Bank of Montreal should continue to perform well, but future growth from record highs will be difficult to achieve.
The dividend should grow at about the rate of earnings-per-share growth in the mid-single digits, implying a payout of $5.00 in 2024. That should keep the yield in the high-3% area, keeping Bank of Montreal firmly in the category of income stocks.
The stock’s price-to-earnings ratio hasn’t moved around much in the past decade and its current multiple of 10.8 compares favorably to its longer term average of 11.7, which we see as fair value. Should the valuation revert back to historical norms, we see a 1.5% annual tailwind from a slightly higher valuation.
Bank of Montreal looks like a decent choice for new investors, particularly now that the stock is trading below fair value. We are forecasting 9.3% in total returns annually looking forward, consisting of the 3.8% dividend yield, 4% earnings-per-share growth, and a 1.5% tailwind from a higher valuation. Bank of Montreal is a strong choice for income investors today and the stock is priced below fair value.
Canadian Bank Stock #3: Toronto-Dominion Bank
Toronto-Dominion Bank traces its lineage back to 1855 when the Bank of Toronto was founded. The small institution – formed by millers and merchants – has since blossomed into a global organization with 85,000 employees and more than CAD$1.3 trillion in assets. The bank has a current market capitalization of CAD$136 billion.
Toronto-Dominion reported Q1 earnings in late February and results were generally in line with expectations. Adjusted earnings-per-share rose a penny to $1.57 year-over-year as strength in some lines of business were offset by weakness in others.
The company’s largest segment, Canadian Retail, saw its adjusted net income rise 6% year-over-year on an 8% revenue gain. The US Retail business saw adjusted net income increase 9% during the quarter as higher loan balances, higher deposits, and stronger interest margins contributed positively.
The Wholesale segment, on the other hand, suffered materially as revenue plummeted 35% and net income was actually negative against a $300 million profit in the year-ago period. Wholesale results were poor enough to offset essentially all of the growth of the other segments for Toronto-Dominion, but given the rebound in equity markets around the world in Q1, this segment should look much better for Q2.
Total revenue during the quarter was up 6.6% provisions for credit losses rose 23%, insurance claims were up 22%, and adjusted noninterest expense gained 7.7%. All of this combined led to virtually flat earnings year-over-year, but as stated, we believe this was a one-time event. We’re still forecasting $6.45 in earnings-per-share for 2019 on a rebound beginning in Q2.
Toronto-Dominion’s capital position remains very strong as well as its common equity tier 1 capital ratio is up to 12% from 10.6% in the year-ago period. In addition, the bank recently boosted its dividend to $2.96 per share annually.
Source: Investor presentation, page 14
The company’s earnings-per-share has been very strong in the past decade. TD has grown earnings-per-share at an average rate of 11% in the past ten years, including growth in every year since 2009. Looking ahead, we expect annual earnings growth of 7%, which is on the lower end of management’s expected growth in the coming years of 7% to 10%. Given the lateness of the current economic cycle, we believe some caution is prudent.
Earnings expansion will come from revenue growth as a result of loan portfolio expansion. Some margin expansion is also on the horizon from higher loan balances, but Toronto-Dominion is already very profitable and its credit losses are stable, meaning that lower losses on loans is unlikely to be a source of margin growth in the near future. Still, given its track record of growth, we believe 7% is a reasonable expectation.
In terms of valuation, the stock has a price-to-earnings ratio of 11.5, which is just under our estimate of fair value at 12 times earnings. A small 0.9% tailwind to total returns may result from the valuation creeping up slightly over time, but overall, the stock looks fairly valued.
We expect 11.8% in annual returns over the next five years, consisting of the company’s 3.9% dividend yield, 7% earnings-per-share growth, and a 0.9% tailwind from the price-to-earnings ratio. Toronto-Dominion is therefore a strong choice for investors looking for a high current yield or earnings-per-share growth, and a stock that is priced reasonably.
Canadian Bank Stock #2: The Royal Bank of Canada
The Royal Bank of Canada, or RBC, offers a wide variety of financial services to its customers, primarily in the U.S. and Canada. RBC traces its history back to the 1860s when it was founded. Today, it is present in 50 countries around the world. It has a market capitalization of CAD$150 billion.
Source: Q1 earnings presentation, page 3
RBC reported its Q1 earnings in late February and results were once again strong. Earnings-per-share were up 7% year-over-year thanks to a 5% increase in net income on a dollar basis, coupled with a small decline in the share count.
Revenue was up a strong 7% during the quarter, but some of that growth was offset by higher expenses. Provisions for credit losses moved a staggering 54% higher in Q1, which is quite unfavorable. That said, the move was due to one capital markets account in the utilities sector, and should not be an issue moving forward. RBC was exposed to a single customer’s failure, but as such, reoccurence of this issue seems unlikely.
Noninterest expenses rose 5% in Q1 against the 7% revenue gain, implying margin expansion on better efficiency. That helped offset the weakness in the capital markets business and helped drive earnings higher in Q1. Net interest margin was down fractionally to 1.62% in Q1, which is very low compared to other banks that tend to be in the high-2% area or better.
RBC’s mix of revenue is unique in that it derives about half of its income from non-traditional banking activities. This means there is much more emphasis on fee generation for RBC rather than net interest income, as you’d expect to see at a bank that focuses more on lending.
We’re reiterating our estimate of $9 in earnings-per-share for this year after an essentially in-line quarterly report, with the exception of the huge credit loss in the capital markets business.
RBC recently boosted its dividend to $4.08 per share and announced it received approval to buy back 1.4% or so of the float.
RBC has grown its earnings-per-share at a rate of 9% since 2008. We are forecasting growth a bit lower than that – 8% annually – moving forward. Its growth will continue to come from its expansion into the U.S., which it accelerated with the acquisition of City National Corporation in California in 2015. RBC is still a small player in the U.S. market and as a result, we see this as its primary growth driver moving forward. The bank will almost certainly continue to grow organically in its home market as well.
The current 3.8% dividend yield is on-par with the other large Canadian banks. We see the payout continuing to rise in the coming years, and dividend growth should roughly keep pace with earnings growth moving forward.
RBC’s long term fair value estimate is a price-to-earnings ratio of 12, but today the stock has a price-to-earnings ratio of just 11.6. This implies a 0.7% boost to total returns over the next five years. RBC offers investors very strong prospective total returns looking ahead. We forecast 12.5% annual total returns, the product of the 3.8% yield, 8% earnings-per-share growth, and 0.7% returns from a rising valuation.
Canadian Bank Stock #1: The Bank of Nova Scotia
The Bank of Nova Scotia, or Scotiabank, is Canada’s third-largest bank with a market capitalization of CAD$87 billion. It traces its roots back to 1832 and since that time, has become a truly global bank.
Scotiabank reported Q1 results in late February and the results were largely as expected. Adjusted earnings-per-share were $1.75, a modest decline of 6% against $1.87 produced in the year-ago period. However, last year’s Q1 results included a $0.12 benefit from the revaluation of the company’s benefit plan, so on a comparable basis, earnings were more or less flat year-over-year.
Total revenue in Q1 was up 7.3% thanks to an 8.6% gain in interest income and a 5.6% boost in noninterest, or fee, income. The international business led the way in terms of growth, but Scotiabank continues to be a very well managed bank.
Provisions for credit losses soared 26% year-over-year, but this was due to growth in the loan portfolio, as well as foreign exchange translation. When a bank grows its loan book, it must take provisions against those new loans, which is what happened to Scotiabank in Q1; this does not reflect a decline in credit quality.
Noninterest expense crimped earnings growth in Q1, rising 19% year-over-year. This was due to integration costs from the bank’s BBVA Chile, MD Financial Management, Jarislowsky, Fraser Limited, and other recent acquisitions. These are not ongoing operational costs, so we aren’t concerned as acquisitions are notoriously expensive to integrate for just about any business.
After Q1 results, we’re reiterating our estimate of $7.45 in earnings-per-share for this year. Scotiabank also recently boosted its dividend to $3.48 per share annually thanks to its very strong capital position.
Source: Investor presentation, page 10
Scotiabank has grown its earnings-per-share at 9% annually in the past decade. It can continue this robust growth, and are therefore forecasting 8% annual growth in earnings going forward. This is roughly in-line with the company’s long term guidance.
Scotiabank could produce growth through loan volume generation, both at home and outside of Canada, as well as expanding operating margins via lower expenses. In addition to that, the bank has proven it isn’t afraid to acquire growth, and we see this as helping to fuel the next leg of earnings growth. Scotiabank’s exposure to economies like Colombia, Chile and Mexico should provide both volume and margin growth in the coming years in excess of what it can produce from its more developed markets. Overall, Scotiabank’s future looks very bright.
Recent weakness in the stock has the dividend yield up to a robust 4.7%, firmly planting it in the category of income stocks. We see the valuation rising over time, which should see the share price rise in excess of dividend growth. In the next five years, the yield should remain near or above 4%, providing investors with a strong source of income for the long term.
Scotiabank’s long term average price-to-earnings ratio is near 12, which is what we see as fair value. The stock trades for just 9.5 times earnings today, implying there could be a meaningful 4.8% tailwind for annual total returns from the rising valuation. Indeed, we see Scotiabank as meaningfully undervalued today given its valuation and track record of growth.
Overall, Scotiabank’s outlook for total returns is very strong. Total returns could reach 17.5% annually for the next five years, consisting of the 4.7% yield, 8% earnings-per-share growth and a 4.8% tailwind from a rising price-to-earnings ratio. Scotiabank provides investors with a unique blend of a high current yield, strong growth and a favorable valuation, meaning it has something for just about any type of investor. We see it as the best Canadian bank stock today.