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The Toronto skyline, looking roughly north east from the 40th floor of 155 Wellington St. West, on March 4, 2019.Fred Lum/The Globe and Mail

All of Canada’s big banks sailed past analysts’ profit estimates when they reported their quarterly financial results last week. But the smaller of the Big Six, with cheaper valuations, scored some of the best share price gains.

This may be something for investors to keep in mind as the market anticipates the end of the pandemic, along with improving economic activity and lower loan losses: A return to normal, or something close to it, could be particularly good for banks that appeared to have the most to lose when the economy was sinking last year.

We highlighted the case of Canadian Imperial Bank of Commerce recently, before the quarterly earnings season began, as a stock with a low valuation relative to its peers. But CIBC, one of the smallest of the Big Six, has company in the bargain bin.

The sector’s financial results for the quarter ended Jan. 31 were widely praised by analysts. Strong trading revenue, robust income from wealth management and aggregate credit losses that were 55 per cent below the consensus expectation, according to National Bank Financial, translated into big surprises.

The banks’ adjusted first-quarter profits, on a per-share basis, actually increased by an average of 14 per cent, year over year. That’s remarkable because it means the banks increased their profits during the pandemic, and by double-digits, even as they faced declining global economic activity and soaring job losses in Canada and the United States last year.

What’s equally remarkable for investors is bank profits beat analysts’ estimates, sending stock prices rising, in some cases to record highs.

The beats were big, too. Among the biggest of the big banks, Royal Bank of Canada’s adjusted earnings per share were 18 per cent higher than the consensus estimate. Toronto-Dominion Bank’s earnings were 22 per cent higher than the consensus estimate and Bank of Nova Scotia’s were 20 per cent higher.

But the smaller banks produced even bigger beats. National Bank of Canada beat earnings expectations by 26 per cent, CIBC beat expectations by 27 per cent and Bank of Montreal beat by a dazzling 42 per cent.

In most cases, the bigger beats drove bigger subsequent share price gains. Over the past five trading days, the three banks with the biggest beats saw their share prices rise by an average of 4.6 per cent. That’s more than double the 2.2-per-cent average gain for the three banks with the smallest beats (and RBC’s share price has fallen over the past five trading days).

In other words, big beats are good. But perhaps there’s more going on here. The upbeat financial results from the Big Six eased lingering concerns that the sector remains exposed to the pandemic. It is hard to worry about the banks when their excess capital – that is, capital above regulatory thresholds – now stands at a collective $34-billion.

That could fund dividend increases (when the banking regulator gives the green light), acquisitions and share buybacks.

What’s more, cheap stocks stand out as confidence returns. Bank stocks with lower estimated price-to-earnings ratios have emerged as some of the top performers: According to RBC Dominion Securities, CIBC, BMO and Scotiabank trade at an average of just nine times estimated earnings, compared with a P/E ratio of 10.9 for TD at the high end.

The sector itself is still relatively inexpensive compared with the broader market and comes with an attractive average dividend yield of about 4 per cent, supporting the argument for being less choosy among the big banks right now.

But given last week’s strong earnings performance, low valuations could be even more important than features such as size and diversification, which looked attractive during the worst of the pandemic last year. Postpandemic, cheap is good.

Full disclosure: The author owns the BMO Equal Weight Banks Index ETF.

Editor’s note: An earlier version of this story incorrectly stated the earnings beat for Bank of Nova Scotia. It has been updated.

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