Canadian bank stocks may have stumbled but they remain compelling investment opportunities.Mark Blinch/Reuters
Canadian bank stocks struggled in 2022, as tumbling share prices underperformed the S&P/TSX Composite Index. But the sector’s strong long-term performance and reliable dividends are compelling reasons for investors to give banks another look – so where should they look for opportunities?
Perhaps this scorecard can help. By examining bank stock performance using some of the more popular approaches, investors can see what went right and what went wrong in 2022, and get a glimpse of potential ideas for 2023.
Ignore the stock, buy the dividend: Since bank dividends are rock-solid, buying the bank stock with the highest dividend yield has some appeal. A high yield suggests that the stock may be undervalued. It also means that the stock will deliver more cash, adding to its total return.
Did this approach deliver results this year? No.
The stock with the highest yield at the end of 2021 was Bank of Nova Scotia BNS-T, at 4.5 per cent, followed closely by Canadian Imperial Bank of Commerce CM-T, at 4.4 per cent. But both stocks delivered the worst returns among the Big Six banks, falling 26 per cent each in 2022, as of early Friday.
Using dividend yield as a stock-picking technique for 2023 delivers the same two candidates, but with even bigger yields. Scotiabank now yields 6.3 per cent while CIBC yields 6.2 per cent. For investors who like income, these yields may be hard to resist.
The worst stock is the best stock: Canadian banks have an uncanny ability to bounce back from a losing streak – a trend known as reverting to the mean – so buying the previous year’s worst performer can deliver attractive results.
Did this approach work in 2022? Absolutely.
Royal Bank of Canada RY-T was the sector’s laggard in 2021, when the share price trailed all of its peers and lagged the average return for the Big Six banks by about six percentage points. An investor who picked RBC for 2022, based on this laggard status, suffered a modest loss of 5.2 per cent this year (none of the returns used in this story include dividends). Though that tied National Bank of Canada’s decline, it outperformed the Big Six average return by a substantial 8.8 percentage points.
Using this technique to pick a winner for 2023 means sidling up to Scotiabank or CIBC and embracing their 26-per-cent declines this year as a reason to be enthusiastic about the stocks.
The lowest valuation shines brightest: Analysts use a number of ways to look at bank stock valuations, but one of the simplest compares the current share price to estimated earnings.
If cheap is good, then the best pick for 2022 was CIBC, with a sector-trailing price-to-earnings ratio of 9.8 at the start of the year. That compared with a peer average P/E of about 10.5, according to Bloomberg data.
The problem: This year, cheap got cheaper. CIBC’s P/E ratio fell to about eight in December after the bank’s share price slumped.
For investors who want to take another crack at picking a bank stock using this approach to valuation, Scotiabank is on track to end the year with the sector’s lowest P/E, at 7.8, edging out CIBC as the bargain bank for 2023.
Just buy them all: Anyone who doesn’t trust their stock-picking skills may prefer the diversification of an entire basket of Canadian bank stocks using an exchange-traded fund. You won’t get individual winners this way, but you won’t be saddled with laggards either.
Some of the leading ETFs take different approaches, though.
The RBC Canadian Bank Yield Index ETF (RBNK) holds the Big Six bank stocks weighted according to their dividend yields. The two highest-yielding stocks each account for a quarter of the fund; the two lowest-yielding stocks each account for a twelfth of the fund. The ETF fell 16.2 per cent in 2022.
The BMO Equal Weight Banks Index ETF (ZEB) holds an equal weighting of all six big-bank stocks, and is frequently rebalanced. The fund fell 13.5 per cent in 2022.
The Hamilton Enhanced Canadian Bank ETF (HCAL) puts a heavier weighting on stocks that have been underperforming, using a revert-to-the-mean strategy. It also provides 25-per-cent leverage, boosting an investor’s exposure to the sector and enhancing dividends. With bank stocks down this year, though, the unit price has slumped 22.5 per cent.
Clearly, equal weighting worked best for ETFs during the market turbulence of 2022 – though bank investors had nothing to brag about with any ETF or stock-picking approach this year, given the slump.
The nice thing about bank stocks? Over the long term, they all deliver good returns, even when you choose wrong.
Full disclosure: The author owns units of ZEB.
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