What are we looking for?
Strong, sustainable yield from an undervalued sector.
The screen
The financials sector has by far the lowest forward valuation, as measured by SmartEstimate forward price-to-earnings, of any sector in Canada. At less than 12 times, it is roughly 50 per cent lower than the next least-expensive – consumer cyclicals.
Interest rates are also rising in Canada. The Bank of Canada hiked the overnight rate at its last meeting, and it is more than likely that it will do so at least one more time this year (implied by market trading). When interest rates go up, the value of fixed income securities, such as bonds, fall. For Canadian investors in search of yield in this rising, albeit historically low, interest-rate environment, stocks in the attractively valued financials sector that pay a high, sustainable dividend may be a better option than bonds, which have a much more limited upside.
Our universe for the screen will be companies in the Thomson Reuters Business Classification financials economic sector that trade in Canada. The first measure we will screen on is the forward P/E SmartEstimate mentioned earlier, and we require a P/E ratio of less than 12.5 times.
Next, we screen for companies whose SmartEstimate dividend yield is greater than 4.5 per cent.
Finally, we use the StarMine Credit Combined Sector Rank to ensure we are buying companies that are paying a sustainable yield. The model considers things such as structural leverage; profitability, coverage and liquidity ratios; as well as artificial intelligence and text mining to assess the inherent creditworthiness of a company. We don't necessarily need a company to score high, as we are buying equity rather than debt, but we want to avoid companies in the bottom 30 percentile. If, in the future, a company looks as if it may have trouble meeting its debt obligation, both a drop in the price of the stock and a slashing of the dividend are likely scenarios.
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What did we find?
Interestingly, CIBC, the smallest of the Big Five, is the only one of Canada's big banks to pass the criteria laid out in the screen.
It isn't surprising, however, that in a screen for yield that real estate investment trusts would be heavily favoured (REITs must return a high percentage of their income as a distribution to maintain tax-advantaged status), and in fact five of the nine companies are REITs.
Dream Global REIT's stock has performed very well recently, appreciating more than 20 per cent over the past nine months and gaining favour with the analysts who cover it. Dream Global allows Canadian investors to diversify and indirectly invest in commercial property outside of Canada – specifically in Germany and Austria.
Outside of REITs, Gluskin Sheff + Associates Inc. is an interesting case. Although it has the highest P/E in the screen, this value is well below the average of its peers (North American traditional asset managers). Gluskin Sheff provides discretionary investment management services to high-net-worth private clients and institutional investors. This business model means it won't face some of the main pressures affecting the industry at the moment in the same way as many of its peers – such as pressures coming from robo-advisers and new fee-transparency regulations.
Investors are advised to do their own research before investing in any of the securities listed here.
Hugh Smith, MBA, works in the financial and risk unit of Thomson Reuters and specializes in wealth and asset management.