Canadian Banks: A Potential BargainSep. 6, 2022
- Canadian banks wrapped up its third quarter earnings reporting, which ended up being mixed overall. In addition, anticipation of a pending recession are weighing on the group, with the expectation of an economic slowdown weighing on various lines of the businesses and higher interest rates leading to potential loan losses.
- While it can be argued that inflation has peaked, there still is no certainty that we will see the consumer price index (CPI) return to the Bank of Canada’s (BoC) target range of 2% anytime soon. As a result, we will likely see further rate hikes by the BoC, which would place further stress on the economy and the profitability of the banks.
- While many of the tailwinds for the banks during the pandemic have turned to headwinds, much of the negativity has already been priced in. Comparing the average current price-to-earnings (P/E) and forward P/E ratios of the “Big Six,” Canadian banks show a discount of -27.9% and -23.1%, relative to the S&P/TSX Composite (TSX). This indicates that, for long-term investors, this may be an attractive entry point for the Canadian banks.
- On a price basis, banks have also fallen on average -22.5% from its 52-week highs, while the TSX has fallen a comparably lower -13.9%. In addition, the banks have an average gross dividend yield of 4.8%, versus the the TSX at 3.2%. Higher dividends have historically been a reliable indicator of forward returns on the banks in the past, as shown in a recent article by Chris Heakes and Chris McHaney.
Banks look attractive relative to the broader market
Discount to 52-Week High
- Investors can efficiently access the “Big Six” Canadian banks using the BMO Equal Weight Banks Index ETF (ticker: ZEB). This ETF has seen significant net inflows of over $600 million year-to-date. This is due to many investors using ZEB to get exposure to the banks, given the group’s attractive fundamentals.
- While economic uncertainty will likely weigh on banking activity, thus leading to potential loan losses, it should be noted that Canadian banks have a strong historical track record of conservative management and operate in an industry that has significant barriers to entry. This is one of the primary reasons why banks often make up a core position in most Canadian investors’ portfolios.
- Additionally, with the share prices of banks down year-to-date, investors may want to take advantage of this by utilizing a tax loss harvesting strategy. Investors can sell shares of banks to crystalize the loss, which can be used to offset gains in other parts of a portfolio. The BMO Equal Weight Canadian Banks ETF (ticker: ZEB) can then be used to maintain exposure to the banks. For financial advisors looking to utilize this tax loss harvesting strategy, reach out to your ETF specialist.
- Investors looking to extract yield, or those believing the prices of banks will be more rangebound, may want to consider the BMO Covered Call Banks ETF (ticker: ZWB), which also invests in the “Big Six” Canadian banks, using an equal weighting, but implements an additional covered call overlay that allows the portfolio to currently generate a gross yield of 7.8%.1
1 Bloomberg, as of August 31, 2022.
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