If you’re buying bank stocks for their dividend yields, you might be looking at the wrong feature.
Dividends have been getting a lot of attention this week, given that it is the first time that the banks have raised their dividends since the pandemic began over a year and a half ago. The biggest banks boosted their payouts by an average of 15 per cent when they reported their fiscal fourth-quarter results this week.
While bigger payouts are nice, though, dividend yields have had little impact on the banks’ share price performance over the past three years – a period that includes the normal economic backdrop of 2019, the stock market selloff in early 2020 and the recovery since then.
At the end of the banks’ fourth quarter in 2018, Bank of Nova Scotia and Canadian Imperial Bank of Commerce beckoned investors with yields of 4.6 per cent and 4.7 per cent, respectively – the highest yields among the Big Six.
However, the strategy of buying the highest-yielding bank stocks didn’t reward investors with outsized gains over the past three years. CIBC’s share price gained 30 per cent over this period, below the peer average of 38.5 per cent. Scotiabank gained just 17 per cent over the same period, trailing all of its peers.
On the other hand, bank stocks with lower dividend yields in 2018 performed much better.
Bank of Montreal , with a yield of just 3.9 per cent three years ago, saw its share price rise 48 per cent since then. And National Bank of Canada – with a middling dividend yield of 4.1 per cent, which was the average for the Big Six in 2018 – gained 63 per cent over the past three years, beating all of its peers.
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If bigger dividend yields haven’t translated into stronger share price gains, what has driven shares? If National Bank and BMO are any indication, profit and revenue growth – which are now underpinning stronger dividend growth – are the key factors driving share price performance.
BMO has led the way with three-year annual profit growth of 42.3 per cent. National Bank is a close second with profit growth of 39.7 per cent.
Both banks also reported the biggest improvement in return on equity – or ROE, a profitability ratio that compares net income to shareholder equity. BMO’s ROE has expanded by 1.7 percentage points over the past three years. National Bank’s ROE showed an even better improvement, rising 2.3 percentage points.
BMO and National Bank also led the way with three-year revenue growth of 18.2 per cent and 24.6 per cent, respectively. Compare that to Scotiabank and CIBC – the banks with the highest dividend yields in 2018 – where revenue growth lagged at 8.6 per cent and 12.1 per cent.
Instead of focusing on bank stocks with the biggest dividend yields, then, the better approach may be to sidestep the current yield and look at the potential for dividend growth.
A good place to start: payout ratios. This metric compares the current dividend payout to profits, and provides an indication of how much room there is for additional hikes. As profits grow, the payout ratio shrinks – justifying bigger dividends and, ideally, propelling the stock price.
National Bank, which raised its dividend by 23 per cent this week, now has a payout ratio of 39 per cent. That’s the lowest among the Big Six and below the bank’s target range of 40 per cent to 50 per cent. BMO, which raised its dividend by 25 per cent, has a payout ratio of 41 per cent, which is at the low end of its target range and below Royal Bank of Canada, Toronto-Dominion Bank, CIBC and Scotiabank.
“The key takeaway when it comes to dividend increases in the quarter is that the banks that had the largest increases to their dividends, BMO and National Bank, will continue to have the largest (and quickest) growth moving forward,” John Aiken, an analyst at Barclays, said in a note.
Investing in bank stocks for their dividends is a great idea. But if you want stocks that outperform, growth matters more than yield.
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