By: David Baskin
The Canadian banks hit a rough patch last week. Or rather, their share prices did. The two things are quite different. The banks reported strong earnings for the year ended Oct. 31st. Most commented that conditions going forward will present challenges, and that the rate of profit growth would likely slow in 2015. Nonetheless, the banks continue to be the most consistently profitable companies in Canada and the most rewarding investments for long-term shareholders. We think that will be the case going forward too. Here are some reasons why.
1. Canadian banks are all trading below 11.5 times expected earnings for 2015, even factoring in slowing growth. Compare that to the average 16 times multiple for 2015 earnings on the S&P 500 and these very large, well-managed companies look like bargains. They are.
2. The average dividend yield on the big Canadian banks is a remarkable 3.9%. This is about 70% higher than the average dividend of the S&P 500 companies, and more than twice the yield on 5 year Canada bonds. Historically, bank dividends have been only about 75% of the yield on 5 year Canada’s. From an income point of view, bank stocks have seldom if ever been more attractive.
3. The banks will continue to raise their dividends, although perhaps at a slower rate over the next few years. All have payout ratios below the top end of their published target. Of all the stocks an investor can own, dividend growers are the most profitable over long periods of time. Bear in mind that none of the Canadian banks cut dividends during the dark days of 2008/09, unlike their American counterparts.
4. The banks are well capitalized. All have exceeded the Tier I capital requirements set out in the international rules. Moreover, each has demonstrated the ability to raise additional capital as required very easily, most recently through the issuance of preferred shares paying between 3.75% and 4%.
5. Unlike many other high yielding investments, banks will benefit as interest rates gradually move higher. Loan spreads will improve; higher interest rates will only come when the economy is growing at a faster pace, generating more loan demand and reducing loan losses.
The recent sell-off in bank stocks is understandable given the gloomy headlines that accompanied their earnings announcement. But bear in mind that profits did not fall. They grew, but somewhat slower than forecast. That’s hardly a reason to jettison some of the best investments you can own.