WHAT ARE WE LOOKING FOR?
After a pair of bleak quarters in which Canada's Big Six bank stocks sank almost 20 per cent, investors have started retesting the waters of the sector, long a blue-chip mainstay of many portfolios.
Mouth-watering dividend yields are a key attraction: Bank stocks are now yielding 4 per cent, topping the yield on the Canadian government's 10-year bond (currently at 3.6 per cent) for the first time in decades.
But which banks to buy? For that, we return to well-regarded equity quantitative-analysis firm CPMS Computerized Portfolio Management Services Inc., which has crunched the Canadian banking numbers and identified the key metrics that historically have pointed to superior stock performance.
PRICE-TO-BOOK IS KING
CPMS has back-tested bank stock performance over the past 10 years against a variety of quantitative measures, and found that buying stocks with the lowest price-to-book-value (P/B) ratio would have netted investors the best bang for their buck, outperforming the group as a whole by almost 10 per cent annually. Underperformance in the previous year – as indicated by both the worst 12-month price change and the highest dividend yield, both of which suggest a relatively low stock price – also tended to point to superior returns in the year that followed, with better than 4-per-cent outperformance of the group benchmark.
Conversely, bank stocks with the best price gains over the prior 12 months and the lowest dividend yields tended to be duds, underperforming the benchmark by the biggest margins.
THE RESULTS
Bank of Montreal
, whose stock has been battered by credit-market-related writedowns and natural-gas trading losses, looks poised to outperform. It has the lowest P/B, worst 12-month returns and highest dividend yield in the group. A key question for the market has been whether BMO remains exposed to further credit-market writedowns, but it does appear that investors are putting those worries behind them: BMO's stock has rebounded 31 per cent from its mid-March lows.
Toronto-Dominion Bank
, on the other hand, scores highest on the two biggest indicators for underperformance – best 12-month price change and lowest yield. However, TD does lead the group in another key signpost linked to outperformance, with the best earnings growth over the past four quarters. Earnings momentum may still count for something, especially in uncertain times for the banking sector.
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