What are we looking for?
Interest rates are expected to fall in 2024. What does that do to bank earnings and where are our bank valuations at?
The screen
We used StockCalc’s screener to select the top 10 listed Schedule 1 bank stocks on the TSX by market capitalization. We then used StockCalc’s valuation tools to calculate fundamental (or intrinsic) valuation for each stock to see if it is undervalued or overvalued compared with its price.
Overview of the techniques used:
- Discounted cash flow (DCF value) is a valuation technique in which cash-flow projections are discounted back to the present to calculate value per share. For banks we use a modified DCF;
- A price comparables (price comps) technique values the company on the basis of ratios of selected comparable companies;
- An adjusted book value (ABV) is calculated by multiplying book value per share by a stock’s 10-year average price-to-book ratio.
- If a stock has analyst coverage, we may look at the consensus target price.
More about StockCalc
StockCalc is a fundamental valuation platform with tools to calculate and report on value per share for thousands of public companies listed on major North American stock exchanges. StockCalc also contains numerous tools to understand what the stocks you are investing in are worth.Globe Unlimited subscribers can subscribe to StockCalc using the promo code “Globe30,” which offers a 30-day free trial and special pricing for the second month.
What we found
The Bank of Canada’s policy interest rate currently sits at 5 per cent, up 4.75 percentage points from the low in March, 2020. Money markets are pricing in a full percentage-point cut in the bank’s overnight rate by this October.
During periods of falling interest rates, banks make less on their interest margin (the difference between interest income and interest expense), but that can be offset by more loans, lower loan default rates, greater consumer and business spending and an improved housing market. As rates fall, a rising stock market also means more wealth-management revenue for banks and more capital-markets-related activity.
We look at net interest margin, the price-to-book (PB) ratio and return on equity (ROE) for each bank as part of its valuation. The PB ratio is inherent in our adjusted book value calculation, which is a leading valuation model for banks and other asset-based businesses, such as insurance and real estate.
All the stocks on this list pay a dividend and each except Laurentian Bank of Canada is up over the past 12 months when dividends are included. Let’s look at a couple of them:
Laurentian Bank of Canada LB-T announced a strategic review in July, 2023, that included the possibility of selling all or parts of its business. The stock popped 26 per cent on the news last July 11. In September, Laurentian announced it had completed the strategic review without a deal to sell any of the bank and would focus on an acceleration of its current strategic plan with an increased effort on efficiency and simplification. Laurentian will unveil a renewed strategic plan at its investor day early in 2024. Our models do show upside for LB-T with the understanding it will be executing on a revised strategic plan going forward.
Bank of Nova Scotia BNS-T had the lowest one-year stock price return of the five largest chartered banks in Canada last year. Last month, it announced it is focusing on a renewed strategy in Mexico and anticipates significant earnings from the region within the next five years. The bank has a dividend payout ratio of 72 per cent; however, the bank’s earnings per share have declined over the past five years, which raises concerns about dividend sustainability. Three of our valuation data points are above last Friday’s close price.
You can see in the accompanying table the percentage difference between each stock’s recent closing price and its intrinsic value. The “StockCalc Valuation” column is a weighted calculation derived from the models and analyst target data, if it is used.
Investing involves risk. StockCalc accepts no liability whatsoever for any loss or damage arising from the use of this analysis.
Brian Donovan, CBV, is the president of StockCalc, a Canadian fintech based in Miramichi, N.B.