Canadian bank stocks with low valuations and big dividends have been performing particularly well over the past year, and these same features could help drive outperformance in the months ahead.
If that doesn’t sound like much, consider that CIBC’s Big Six peers have lagged with a total return of minus 1.5 per cent over the same period.
If that’s still not generating anything more than a shrug, then keep in mind that this return includes the devastating market downturn last February and March. From the market’s March low, CIBC’s share price (no dividend this time) has surged 70 per cent – a breathtaking rebound that has beaten the Big Six average gain of 66 per cent over the same period.
The takeaway: Since all of Canada’s biggest banks have emerged from the pandemic looking almost bullet-proof (no bank cut its dividend during the darkest months last year, amid the prospect of surging loan defaults), then undervalued stocks within the sector could shine.
“From a positioning perspective, we continue to believe that investors should be looking towards the valuation laggards as the market’s focus is now squarely on value instead of safety,” Meny Grauman, an analyst at Bank of Nova Scotia, said in a note this week.
The shift toward value could continue to work in favour of CIBC, long relegated to the discount bin because of its perceived higher risk due to a number of high-profile stumbles over the past couple of decades.
Mr. Grauman believes that the forward price-to-earnings ratio, which compares a bank’s share price to its estimated per-share profit, is the valuation metric to watch.
As a group, the Big Six trade at 10.5-times earnings, based on 2022 consensus estimates from analysts. Toronto-Dominion Bank trades at a significant premium of 11.6-times estimated earnings.
But CIBC trails the pack with a consensus forward P/E of just 9.7, despite the stock’s recent gains. What’s more, CIBC has a dividend yield of 5.1 per cent. That is slightly higher than the Big Six average yield of 4.5 per cent and a full percentage point higher than TD and Royal Bank of Canada.
Does CIBC deserve a richer valuation that is more in line with its peers?
During the pandemic selloff in February and March last year, the stock market favoured the biggest, most diversified banks in the belief that behemoths like TD and RBC could withstand the downturn best at a time when banks were threatened with a deluge of bad loans.
The Big Six, as a group, fell about 40 per cent from their highs in mid-February to their lows in March. But RBC and TD performed better, with declines of 34 per cent and 35 per cent, respectively.
Now, though, few are worried about whether the banking sector will crater. Analysts expect that banks have already set aside more than enough money to cover loan losses. And since the Office of the Superintendent of Financial Institutions (or OSFI, the main regulator for the banking sector) told banks last year to hold off on quarterly dividend hikes, the banks have been squirreling away enormous amounts of capital – CIBC included. Eventually, the banks will return this capital to shareholders in the form of dividends or share buybacks.
With prospects looking much brighter, then, low valuations look like a compelling reason to stick with bank stocks.
“We continue to believe valuations have room for improvement as there is a high probability that the Canadian banks’ profitability could rise materially in 2022 to be better than our forecast under our base case scenario,” Darko Mihelic, an analyst at RBC Dominion Securities, said in a note.
For CIBC, the improvement could be bigger than most.
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