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david berman

Canadian Imperial Bank of Commerce has rallied since releasing upbeat quarterly financial results last week and the gains support a simple, but effective, stock-picking strategy.

That is, buy last year's underperforming bank stock. Hold for a year. Repeat.

As we have pointed out in previous articles about this strategy, buying a laggard among the five biggest names in the banking sector works more often than it misfires, producing market-beating results over the longer term.

For data going back to 2000 until the end of last year, this approach has produced an average annual gain of more than 16 per cent (not including dividends). That beats the S&P/TSX composite index by about six percentage points over the same period. About 40 per cent of the time, the previous year's laggard becomes the following year's top performer.

The strategy has also beaten a buy-and-hold strategy. Jumping every year into the worst-performing bank stock has generated a better annual return than simply staying put in a favourite bank stock, such as Royal Bank of Canada or Toronto-Dominion Bank.

It has also delivered better results than buying a basket of bank stocks, picking the bank stock with the lowest price-to-earnings ratio or the one with the highest dividend yield.

In 2016, CIBC wasn't an obvious pick for this strategy. It lagged its biggest peers in the banking sector, but only by a slim margin of about one percentage point. As well, all of Canada's biggest banks enjoyed impressive rallies in 2016, meaning that the laggard wasn't much of a laggard.

Without being a clear underperformer last year, would CIBC stand out from the pack in 2017?

With about a month to go in the year, the results aren't a slam dunk – but they do support this stock-picking strategy.

Since the start of the year, CIBC shares have risen 10.6 per cent, or more than double the return for the S&P/TSX composite index. Again: No dividends have been included. We'll get to that later.

More importantly, CIBC's return is 1.6-percentage-points better than the average for the biggest five banks.

The bank has performed well over the past two trading days in particular, rising a total of 5.6 per cent after the release of fourth-quarter results on Thursday morning.

CIBC reported a quarterly profit of nearly $1.2-billion, up 25 per cent over last year. Adjusted profit was $2.81 a share, up 8 per cent over last year and well above analysts' estimates. Analysts responded by raising their target prices on CIBC by an average of about $7.

The response to CIBC's profit surprise underscores the idea behind this buy-the-laggard strategy: Canadian banks, which operate within a cozy oligopoly, are very good at fixing problems and appealing to disenchanted investors.

In the case of CIBC, it has raised its dividend in 12 of the past 17 quarters – adding the prospect of steady distribution growth to a yield that is already an attractive 4.3 per cent.

The bank also addressed concerns that it was too focused on the domestic Canadian market – where some investors are worried about indebted consumers and hefty home prices in Toronto and Vancouver – by expanding into the United States with its $5-billion acquisition of Chicago-based PrivateBancorp Inc. in June.

Despite CIBC's impressive gains this year, though, it hasn't completely supported our love for laggards.

That's because it hasn't rebounded to the top of the banking sector: It lags front-runner RBC's 11.3-per-cent gain this year. And yes, I know, National Bank of Canada has done even better, with a 16.8-per-cent gain. But we haven't included National Bank into our data because it is considerably smaller than all of its bigger five peers.

With a month to go in the year and some terrific momentum over the past couple of days, perhaps CIBC can emerge a clear winner before 2017 ticks down.

In the meantime, investors who like this approach to choosing Canadian bank stocks may want to consider next year's prospect. Bank of Montreal, which reports its fourth-quarter results on Tuesday, stands out right now. The stock has gained just 3 per cent so far in 2017, trailing the average big bank by 6 percentage points and even lagging the benchmark index.

But with the arrival last month of a new chief executive officer – Darryl White, 46 – expect some fresh ideas at BMO. Mr. White has already pegged technology and U.S. growth as areas deserving greater attention.

Betting on his success is a good idea. Betting on the stock is even better.

Canadian bank gains

CompanyTicker2017 Gain (%)2017 Gain with Dividends (%)
Royal Bank of CanadaRY-T11.315.4
Toronto-Dominion BankTD-T10.714.6
Bank of Nova ScotiaBNS-T9.512.7
Bank of MontrealBMO-T3.06.8
Canadian Imperial Bank of CommerceCM-T10.614.5
Average bank9.012.8
S&P/TSX composite index4.97.6