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Number Cruncher

The best way to buy bank stocks Add to ...

What are we looking for?

Beaten up bank stocks. Why? A sneaking suspicion that they may just be some of the best deals out there.

Number Cruncher has heard it said many times that you just can't go wrong buying Canadian bank stocks. And what's not to like?

It's a cozy oligopoly that turns a pretty penny and it has a good record of returning some of that wealth to shareholders. And, after the recent carnage inflicted on the rest of the world's banks, even the regulatory straightjacket our banks have to wear looks like it's a pretty nice fit.

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You could of course just buy the Big Five outright - settle on a simple equal weight portfolio, rebalanced annually, and be done with it. In fact, history shows that if you were to do just that you would be laughing, well, basically all the way to the bank. The total annualized return for such a portfolio over the last 10-years would have almost tripled the total return for the S&P/TSX composite index.

But, can you do better?

How the screen works

To find out if there's a better strategy for playing the Big Five, Number Cruncher reached out to Jamie Hynes, senior account manager with CPMS, an equity research and portfolio analysis firm owned by Morningstar Canada.

He'd previously run the numbers on the banks for us and discovered that, coming out of the credit crunch, the best strategy had been to buy the worst performing stock each quarter, based on its trailing 12-month share price change, sell it at quarter's end and pick up the new laggard. In fact, across the board in that study, he found that the stocks that had been under the most pressure were the ones most likely to outperform over the next three months.

In order to figure that out, Mr. Hynes looked at a few different criteria and ranked the returns for quarterly trading strategies based on each criterion.

We've asked him to run those numbers again so that we can see if the beaten up bank strategy still works.

What did we find?

The case isn't quite as compelling as it was last time around, but buying the quarter's laggards still looks like a solid strategy if not the best one.

To the end of April, the top strategy over the last 12-months was actually to pay for earnings growth. Each quarter, deciding to own the bank showing the most growth in terms of trailing 12-month earnings per share, would have earned you a 69.7 per cent return, easily outstripping the banks as a group and the S&P/TSX composite.

While digging in to why this was the case, Mr. Hynes discovered that the top bank when it came to earnings growth each quarter was also the top ranked bank when it came to lowest price-to-book value, highest dividend yield or worst twelve-month price change. "Although earnings growth was the top factor, the next three - low price-to-book, worst price change and high yield - all support the 'cheap' bank strategy," Mr. Hynes said.

Among the metrics explicitly tracking the back of the pack, the most profitable one to keep an eye on this time around was a weak share price. Picking up the biggest bank loser, in terms of share price appreciation, over the last year would have netted you a better than 65 per cent return and a solid 8.5 percentage point edge on owning the banks as a group.

What didn't work? Paying for past performance. Picking up the hottest stock for the last year at the end of each quarter was the only way you could have done worse than the S&P/TSX composite with any of these strategies.

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