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number cruncher

What are we looking for?

Last month U.S.-based Merrill Lynch recommended investors make bets against Canadian banks in favour of U.S. banks. Since then, the short interest in the Big Six Canadian banks has risen dramatically. My colleague Rob Belanger and I thought we would take a look at the banking sector on both sides of the border.

The screen

We sorted the banks in both countries from the largest to the smallest based on the market capitalization.

The price-to-book ratio (P/B) is the current share price divided by the book value per share. A low P/B could mean the company is undervalued.

Forward P/E is the price-to-earnings ratio using the consensus of analysts' forecasted earnings. We would prefer a low number.

The Tier 1 capital ratio is a comparison between a banking firm's core equity capital and its total risk-weighted assets. The ratio is a good indicator of a bank's financial strength. We are looking for a high number.

The return on equity (ROE) measures how efficiently a company can generate profits from its capital. It shows whether a company is a profit creator or a profit burner, and if it is growing profits without pouring new capital into the business. A high number is preferable.

Tangible common equity is another measure of leverage used to evaluate a financial institution's ability to deal with potential losses, and we are looking for a high number.

The non-performing assets (NPA) to total assets refers to loans that are in jeopardy of defaulting compared to the bank's total assets. We are looking for a low number in this category.

The net interest margin is a performance metric that examines the success of a bank's investment decisions compared to its debt. A negative value denotes that a firm did not make optimal decisions since interest expenses were greater than the amount of returns generated by investments. The higher the number, the better.

We are also including the dividend yield per share.

What did we find?

Looking at the averages of the eight columns, the Canadian banks lead in four categories (forward P/E, return on equity, NPA to total assets and dividend yield) and the U.S. banks also lead in four categories (P/B, Tier 1 capital, tangible common equity and net interest margin).

Investors should conduct further research or contact an investment professional before buying any of the securities listed here.

Michael Bowman is a portfolio manager at Hamilton-based Wickham Investment Counsel Inc., an adviser to high-net-worth clients.

Canadian and U.S. banks