Regardless of your investment philosophy, most Canadian retail investors will have one thing in common when it comes to their portfolios; they include Canadian bank stocks.
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If you are looking for growth, or income, Canadian banks have rewarded investors and will continue to do so for years to come. They are the backbone of Canada’s stock market and among them are some of the safest blue chip companies in the world. We looked for Canadian bank stocks that pay dividends, have consistent growth, and a solid foundation in this guide.
The Canadian banking market is highly regulated and as such, there are massive barriers to entry. The Big “5” being:
- Bank of Nova Scotia
- Bank of Montreal
- Royal Bank
- TD Bank
are incredibly important to the Canadian economy as are some of the smaller regional players such as National Bank of Canada and Western Bank.
A Canadian bank stock can serve as a cornerstone of one’s portfolio, is low-risk, provides growth and a steady income. After weathering the financial crisis better than most all world-banks, the Canadian banks were also among the first to re-instate a rising dividend.
On top of historical performance, the banks are currently enjoying some tailwinds which have the potential to propel the sector even higher. The Canadian economy is growing at a fairly good clip, good enough for the Bank of Canada to start rising interest rates, twice in the past 6 months.
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But anyways, lets get down to the brass tacks. Here are the top 5 Canadian bank stocks you can buy right now. Along with our opinions on these stocks, Mike McNeil from The Dividend Guy Blog and Dividend Stocks Rock has decided to provide some input on Royal Bank and his favorite bank right now in Canada. Enjoy!
Canadian Bank Stocks
5.Bank of Nova Scotia
Kicking off our list of the top Canadian bank stocks is Scotiabank.
The Bank of Nova Scotia is perhaps Canada’s most innovative bank and has been first to market with many online initiatives. It has 70% digital penetration from its customers, and 50% of retail sales were generated digitally.
Although dividends have been rising, it also has the highest payout ratio among the big 5 at 67.68%.
BNS’ is perhaps most impacted by their international segment with operations in Asia, Latin America, and the Caribbean. The company expects 10% growth in this segment driven primarily by their Pacific Alliance countries (Mexico, Peru, Chile, and Columbia). This past fall, the company announced it was disposing of its Caribbean assets. This will be a positive for the company as the segment has been a drag on results.
Another point for investors to note, BNS may be one of the banks most exposed to a potential housing crash as the majority of their mortgage loans are held in Toronto and Vancouver.
4.RBC Royal Bank
Royal Bank is Canada’s largest bank by market capitalization and is also the most diversified with operations worldwide. That being said, RBC is still very dependent on the Canadian customer with 61% of revenue originating from Canadian operations.
It has captured the highest market share in several Canadian retail banking products including Personal Lending, Total Mutual Funds, Business Loans and Deposits. For the first time in years, RBC underperformed the Big Five in 2018. That being said, it has been one of the best performing banks over the past 5 years RBC, its share price returning 43% or 7.2% on annual basis.
The company continues to deliver a rising dividend and has the exact same targeted payout ratio as TD at 40-50% of earnings. As of today, its payout ratio is 47.58%, on of the highest among the group. As such future dividend increases will be most likely tied directly to earnings growth. Earnings which are expected to grow at one of the slowest rates in the sector. Hence, one of the main reasons it finds itself near the bottom of our list.
Mike: Royal Bank is the largest bank of the group by market cap, and provides various financial services to individuals as well as commercial and institutional clients. RY has a strong position in the personal and commercial banking sector (50% of its revenue). In 2015, RY bought City National, a Los Angeles-based bank focused on high net worth clients. The transaction opened US doors and another growth vector: wealth management.
The Canadian banking system is one of the most robust and safe in the world. Having the chance to invest in a leader in such a market is a no-brainer. Royal Bank shows a great balance in revenue source with a 50% core business coming from P&C and counting of various growth vectors such as wealth management, insurance and capital markets.
3. Canadian Imperial Bank of Commerce
Coming in at #3 on our list is CIBC. CIBC is currently one of the most undervalued As of writing, it has the lowest P/E and P/B among its peers. It has been one of the cheapest banks in Canada for a few years running.
The company also sports the highest yield of the group with an attractive 4.62% to go with its 147 year dividend streak. In terms of Canadian bank stocks that pay dividends, it is one of the best.
The company has been expanding its US operations through acquisition. It recently acquired Private Bancorp and Geneva Advisors, a wealth management company. These acquisitions are key to diversify the company’s operations.
Unfortunately, it hasn’t been enough to convince investors. The company has chronically underperformed the group. It was the worst performing bank in 2018 and has been one of the worst over the past five years. However, research has shown that the worst performing bank has typically outperformed in the year following. It is mainly for this reason the company finds itself third on our list.
2. Bank of Montreal
Climbing from #5 in 2018 to #2 this year, the Bank of Montreal is our runner up. The Bank of Montreal has the longest dividend streak in Canada spanning almost two centuries at 188 years.
The feat is incredible and speaks to both their longevity and consistency. Much like their peers, it begun raising dividends once again after successfully navigating the financial crisis. At 45.40%, the company has the lowest payout ratio of the group. As such, it is best positioned to grow dividends above historical averages.
Another aspect working in its favour – BMO is the least exposed among the big 5 to the Canadian housing market. With so much talk of a potential housing crash, BMO is ideally situated to navigate any downturn in the housing market.
Furthermore, the bank is currently looking to rapidly expand its US operations with plans of expansion into Southern California and Ohio.
Analysts have become increasingly bullish on the stock and it is now expected to have one of the highest growth rates among Canada’s big 5. In comparison, the company has the lowest expected growth rate among the big 5 at the beginning of 2018.
1. TD Canada Trust
The best Canadian bank stock to buy is still Toronto-Dominion Bank. TD Canada Trust is a leading North America bank who is ranked #1 in Canada and 5th in North America in terms of total assets and total deposits. The company is ideally positioned to take advantage of rising interest rates on both sides of the border.
Over the past 5 years, the company has an earnings compound annual growth rate of 10.04% and has a medium term earnings growth target of 7-10%. This is the highest growth rate among its peers. Likewise its share price outperfomance has spanned 10+ years. No bank has rewarded shareholders more.
The company also has a rising dividend, and their 3YR (9.3%), 5YR (11%) and 10YR (8.3%) are the highest growth rates among all of Canada’s big 5 banks.
Its targeted dividend payout ratio is 40-50% which is good news for investors as their current payout ratio is 44.61% leaving ample room for future dividend growth.
There is nothing not to like about TD Bank and its still Canada’s best.
What should I look for when picking Canadian Bank stocks?
We alluded to it earlier, but there are two main groupings of Canadian banks, the Big 5 and the smaller regional players. The Big 5 are not only the largest Canadian bank stocks by market capitalization, but they also have operations south of the border and many have international operations.
On the other hand, the regional banks are mainly focused on the Canadian market with little to no international operations.
Interest rates are always a hot topic and rising interest rates are a positive for banks. Rising rates result in a larger spread between lending rate to customers and the rate to which it pays its debtors.
As a result, they have a positive impact on profitability as net interest income (NII) margins rise. Banks in which retail earnings account for a high percentage or income will be best positioned to benefit.
Could rising interest rates hurt the outlook of Canadian banks today?
On the flip side, there is the risk that rising interest rates will result in greater loan defaults. It’s no secret that ultra-low interest rates have led to a significant amount of borrowing and Canadians are now more indebted than at any other point in history.
Of particular concern is Canada’s housing market. Pundits have been calling for a housing crash for years as low rates have sparked home prices to rise significantly, especially in the Vancouver and Toronto markets. The concern was real, and the Canadian and Provincial Governments have stepped in and introduced new mortgage rules to curb high prices.
The result is being felt as house prices have started to taper and sales have also started to slow. The good news is, so far the impact has been gradual and hasn’t resulted in a hard crash like the U.S. experienced during the financial crisis. It is important to understand and keep tabs on housing as Canada’s banks have a good number of these mortgages on their books and a hard crash could result in high defaults and write downs.
Banks that have a high percentage of their mortgage portfolio in the larger centers such as Vancouver and Toronto are particularly vulnerable to this risk.
Canada’s bank stocks pay rich dividends
You can’t have a conversation about banks without discussing dividends. Canada’s banks were the envy of most when, unlike their U.S. peers who slashed dividends, they managed to weather the financial crisis without cutting their dividends.
The question now becomes, who is best positioned to continue raising dividends and at what rates? Look for banks that have raised for at least 5+ years and have a clear dividend policy. If you’re looking for some of the best dividend stocks to buy, check out our list of the top 23 in Canada.
Look at the bank capital adequacy ratio
Another key metric to review is bank capital adequacy ratio. These legal requirements (Basel Accord III) were implemented to address deficiencies in financial regulation exposed by the financial crisis. Specifically, the Tier 1 Capital ratio (CET1) evaluates a bank’s financial strength and can be used to as a quick reference to gage a bank’s capital strength.
Investors can also use this ratio to compare banks against each other and the higher the CET1 ratio, the better. Of note, according to the Basel III Accord, banks must have a minimum CET1 ratio of 4.50% by 2019. In Q3, Canadian banks averaged a CET ratio greater than 11% and are well positioned to weather a downturn in the economy.
So what do you think? If you had the choice would you leave these rankings as they are? Let us know the 5 banks that would never let you down in the comments below!