Whether you're a seasoned investor or someone who is just learning how to buy stocks in Canada, most Canadian retail investors will have one thing in common when it comes to their portfolios; they include Canadian bank stocks.
Well, for starters, every one of these banks on this list is a Canadian Dividend Aristocrat, and is also included in the large majority of Canadian index etfs. Newcomers looking to learn how to buy stocks are often drawn to bank stocks, primarily because of their consistent, high-paying dividends.
Are Canadian banks a good buy now?
Now that the rollout of vaccines are in full swing and the economy is slowly starting to re-open, Canada’s banks are seeing strong positive momentum.
They are also riding the tailwinds of the threat of rising rates as the risk of hyper inflation increases by the day.
It is therefore not surprising that Canada’s banks have largely recovered from the pre-pandemic lows and are trading at 52-week highs.
It is also worth noting that as a group they underperformed the TSX Index in 2020.
It marked the first time in several years that every single bank underperformed the broader Index.
The good news is that in 2021, they have once again started to outperform. In fact, through the first few months of the year, every single one of Canada’s banks are outperforming the Index.
Despite the runup in price, the potential for rising rates and a strong economic rebound are reasons enough to start or add to your positions today. Even without those tailwinds, Canada’s Banks are among the strongest investments in the country.
Will dividend growth return for Canada's top bank stocks?
One of the current drawbacks to these Canadian stocks, is their inability to raise dividends.
At the onset of the pandemic, the Office of the Superintendent of Financial Institutions (OFSI) put a cap on dividend raises.
Among other temporary initiatives, these measures were put in place due to the considerable uncertainty that clouded the industry. The good news is that banks have proven capable and the impacts haven’t been as bad as feared.
Furthermore, these measures were not a reflection of their financial positions. The banks are excellent stocks, and the measures were implemented out of an abundance of caution.
The good news is that the OFSI has started to rollback these temporary measures.
While dividend raises have not been given the green light, it is only a matter of time.
Once the go-ahead is given, expect all of Canada’s banks to resume their strong history of dividend growth.
How safe are Canadian bank stocks?
The highly regulated Canadian banking market creates massive barriers to entry. This is very similar to the Canadian telecom sector.
The Big 5 are incredibly important to the economy in Canada, as are some of the smaller regional players such as National Bank of Canada and Canadian 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 banks in Canada were also among the first to re-instate a rising dividend. In fact, the Bank of Montreal has one of the longest consecutive dividend payment streaks in the country at 189 years.
One of the most reliable ways to value Canada’s banks is to compare their existing valuations against historical averages. Whether they traded at a discount or premium to historical and forward P/E averages, they always return to the mean.
So with that being said, let’s get to the best Canadian bank stocks to buy moving forward.
What are the best Canadian bank stocks to own today?
5. Canadian Imperial Bank of Commerce (TSX:CM)
CIBC (TSE:CM) kicks off our list of the best Canadian bank stocks to be looking at today. Overall, CIBC has been a perennial under-performer, but makes the cut on this list update over the Bank of Nova Scotia.
Investors who have held CIBC over the past year may have been pleasantly surprised. For the first time in years, they started to perform inline with the peer average.
Is this but a blip on the radar or a sign that CIBC is finally on the verge of turning a corner?
The company is expected to post earnings growth in the mid-single digits, which is above the industry average.
Normally, we’d reward the company with a higher ranking because of higher growth rates, but as mentioned CIBC hasn’t had the greatest track record.
That being said, if it does deliver then the company is well positioned to outperform for the balance of the year. Through the first few months of the year, it has rewarded with returns at the mid-range of its peers.
In terms of valuation, CIBC remains one of the cheaper banks but is trading well above historical averages. At 13.3 times earnings and 1.4 times book value, CIBC is trading at a 12% premium to historical averages.
Also worth noting, CIBC also boasts the largest dividend of any bank stock on this list at 4.75%.
Typically, CIBC sports one of the highest yields among its peers and this time is no different. While it is slightly below its average (4.95%), investors should be more than happy with this type of yield.
While the dividend is safe, a payout ratio of 61.48% is the highest among its peers, and as such is likely to deliver below average dividend growth.
Keep in mind however, with a higher than expected EPS growth rate, that payout ratio is expected to drop next year.
Canadian Imperial Bank of Commerce 10 year performance vs the TSX
4. Bank of Montreal (TSX:BMO)
During the pandemic, the Bank of Montreal (TSE:BMO) was the hardest hit bank. In fact, for most of 2020 the bank trailed its peers.
That is until the markets recognized it was significantly undervalued and it quickly became one of the best performing banks. This is exactly why we relayed the Bank of Montreal to Stocktrades Premium members
As of writing, BMO leads all the Big Six banks with returns of 66% over the past year.
The Bank of Montreal is the 8th largest bank in North America, and has paid uninterrupted dividends for more than 185 years, the longest streak in the country.
Just over 60% of its revenue comes from the Canadian economy, making it one of the more heavily dependent Canadian bank stocks when it comes to its home country.
One of the drawbacks against the company - High exposure to the oil and gas industry.
However, its key to note that the company also has the lowest exposure to the Canadian housing market, a market which a lot of investors think is a bubble just waiting to burst.
Furthermore more, the Bank of Montreal has been one of the most consistent performers among all of Canada’s banks. Outside of this past year where previous underperformance has led to it leading its peers, BMO has consistently been middle of the pack in terms of performance.
Over the past 3, 5 and 10-year periods, BMO has closely trailed the top 3 on this list, but has far outperformed the laggards.
As mentioned in our prelude, when Canada’s banks start to dip below historical averages, it is time to back up the truck.
In the case of the Bank of Montreal, it has five-year median P/E and P/B ratios of 12.08 and 1.48 respectively.
Currently it is trading above its historical P/E average. However, it is worth noting that BMO is one of only a few banks expected to grow revenue in excess of 4% this year.
Earnings are also expected to jump by 37% which is the highest among all the Big Six banks. Given his, the current P/E ratio is somewhat inflated. On a forward basis, the P/E ratio drops to 10.64 which is below its 5-YR average of 10.78.
Bank of Montreal 10 year performance vs the TSX
3. Toronto Dominion Bank (TSX:TD)
Toronto Dominion (TSE:TD) slips to number 3 on our list. Not because it has been a poor performer, but because of outperformance by another (more on that later).
TD is a multinational banking and financial services firm which started operations in 1855. TD Bank is one of the largest banks in Canada by total assets and second largest by market capitalization.
The $150 billion dollar company has the highest exposure south of the border as more than 40% of revenue comes from the U.S.
The financial giant was named one of the most convenient banks in the U.S. and is among the top brands in North America.
Over the past five years, TD Bank has averaged 6.83% and 8.79% annual earnings growth. This includes the pandemic which had severely impacted operations.
These are the highest growth rates among any of the Big Six banks. This is one of the primary reasons TD Bank has been able to grow its dividend at a rapid pace and owns the highest dividend growth rate of its peers.
Surprisingly, it has trailed the top 2 stocks on this list in terms of stock performance. That is the only reason why TD is ranked 3rd on our list.
However, don’t sleep on TD Bank as its exposure to the U.S. can lead to outperformance as our neighbors have had a much more successful vaccine rollout and are opening much faster than we are here in Canada.
As of writing, TD Bank is trading below its historical five-year P/E & P/B averages of 12.54 and 1.70 respectively.
This makes it one of the more attractively bank options on the Index today.
TD Bank 10 year performance vs the TSX
2. National Bank (TSX:NA)
National Bank (TSE:NA) jumps to number 2 on our list.
Why? It simply continues to defy expectations and outperform. It is the second best performing bank over the past year, and has been the best bank to own over the past 3, 5 and 10-year periods.
National Bank is dominating in terms of market share in Quebec, with over 60% of its revenue coming from the Canadian province. The bank also depends heavily on personal and commercial banking, making up over 42% of its total revenue.
A lot of naysayers compare National Bank to a company like Laurentian Bank, who recently had to cut its dividend amidst the pandemic. However, it's important to note that National Bank does have a strong international presence as well.
Although it's smaller than that of Canada's major institutions, glass half full investors will realize this is a prime opportunity to grab a growth stock in the banking sector, which is an extremely rare occurrence.
Over the last 5 years, National Bank (dividends accounted for) has returned 100.2% to investors. The next closest bank? Royal Bank at 54.4%. In fact, National Bank more than doubled the performance of every one of Canada’s Big 5 except Royal Bank.
For the most part, studies around Big Bank valuations have not included National Bank. However, National Bank’s stock reacts in the same way as the big five.
When it trades below historical averages, it always returns to the mean. The opposite is also true, when it trades above historical averages it always drops to trade in line with historical averages.
Today, National bank is trading at a big premium to its five-year historical P/E, forward P/E and P/B ratios of 11.29, 10.28 and 1.80 respectively. In fact, it is the most expensive bank when compared to historical averages.
Next year, National Bank is expected to see revenue and earnings growth of 7.13% and 27.77% respectively.
While revenue growth is above average, earnings growth is average. Given this, we aren’t sure that National Bank deserves to be trading at such a high premium to historical averages.
However, as we’ve mentioned before the company has defied expectations and has led all of Canada’s banks despite having only average growth rates.
National Bank 10 year performance vs the TSX
1. The Royal Bank of Canada (TSX:RY)
Our position on Royal Bank (TSE:RY) hasn’t changed – it remains the top bank in the country.
It continues to perform and was one of the few that managed to grow the top line (revenue) YoY despite the pandemic.
It is one of the most diversified banks in the world, and its global exposure will allow it to provide more stable revenue and earnings as multiple countries are in different phases of economic recovery due to COVID-19. This will remain true though to the end of 2021.
Royal Bank has been the second best performing Big Bank over the past 3, 5 and 10 year periods.
If you were solely looking at the Big Five, then it would be the top ranked performer over those periods.
The same valuation principles apply to Royal Bank. The company is currently trading at premium to its five-year P/E average of 12.44 but at a discount to its P/B average of 1.9. On a forward P/E basis, it is trading right in line with historical averages.
All things considered, it looks to be fairly valued here. This means that it should simply perform line with expectations. Revenue and earnings are expected grow by around 4% and 23% next year.
Given its size and status as the largest company in the country, Royal Bank provides unparalleled safety.
It is one of those rare stocks that you can buy at any point. While you don’t necessarily want to overpay, today the company is well priced and should continue to do well for years to come.