What are we looking for?
Undervalued Canadian lenders with reasonable quality.
Financial services companies can be challenging to value because of the limitations of the free cash flow and dividend models. However, the economic value added (EVA) model is effective in assessing all kinds of financial corporations because of its emphasis on the return on equity (ROE).
Today, we will combine our proprietary score using the EVA approach with a valuation model using both the ROE and price-to-book ratio (P/B).
We screened Canadian lenders with a market capitalization greater than $1-billion.
For informational purposes, we included:
- Stockpointer (SP) score – for financial companies, the score mainly considers risk-adjusted return on equity, earnings-per-share growth and valuation risk based on our discounted EVA model. The score varies between zero and 100. A score of 60 implies a better-than-average company;
- Forecast P/B – we apply a linear regression on our 12 lenders using their respective ROE as “x” and P/B as “y”. We then use the company’s ROE to forecast a P/B based on the linear regression values;
- Value Indicator – Here, we aim to pinpoint stocks whose P/B does not accurately represent their ROE. We start by subtracting the P/B to the forecast P/B. If the result is greater than 0.1, it is judged overvalued, lower than minus-0.1, undervalued, and between minus-0.1 and 0.1, fairly valued;
- Three-year annualized dividend growth, trailing-12-month ROE, P/B, one-year price return and dividend yield.
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What we found
EQB Inc. EQB-T tops our list with an SP score of 75 and the highest one-year price appreciation at 48.7 per cent. Based on the value indicator, the company is also undervalued compared with other lenders. While the growth aspect is met with a dividend growth of 24.2 per cent in the past three years, dividend investors could be slightly disappointed by the dividend yield of only 2.1 per cent. In terms of dividend yield, this places it at the bottom of our list, tied with Element Fleet Management Corp.
Among the six largest banks, Bank of Montreal BMO-T and Royal Bank of Canada RY-T are regarded to be overvalued, whereas Toronto-Dominion TD-T, National Bank of Canada NA-T, Bank of Montreal BMO-T and Canadian Imperial Bank of Commerce CM-T are considered fairly valued. Only the Bank of Nova Scotia BNS-T stands out as undervalued. Despite having a comparable ROE to Bank of Montreal, the Bank of Nova Scotia’s stock is trading at a P/B of 0.9, in contrast to the Bank of Montreal’s P/B of 1.2.
Canadian Western Bank CWB-T is deemed undervalued and has a SP score of 61, slightly greater than our usual threshold of 60. It ranks as the second-best one-year performer on our list, delivering a solid 18.5 per cent price return. In contrast to EQB, this stock offers relatively slower growth, with a three-year dividend growth rate of 5.4 per cent. However, investors may find this compensated by a more attractive dividend yield of 4.7 per cent.
Laurentian Bank LB-T is considered undervalued by the value indicator, but, in our view, fails the quality test with a SP score of only 45.
Investors are advised to do further research before investing in any of the companies listed in the accompanying table.
For more details about these stocks, subscribe to the Inovestor for Advisors platform for free.
Anthony Ménard, CFA, is vice-president of data management at Inovestor.
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