You might be tempted to invest in Bank of Nova Scotia because of its big dividend yield, low valuation or large emerging-markets footprint. But here’s a better reason: The stock is a dud.
The share price has slumped 13.5 per cent so far in 2018, making it the worst-performing stock among Canada’s five biggest banks. It has underperformed its peers by 7.2 percentage points (not including dividends). And the stock has trailed the year’s best performer, Toronto-Dominion Bank, by 11.3 percentage points.
Scotiabank’s fiscal fourth-quarter earnings report, released on Tuesday morning, didn’t help the situation. The bank missed analysts' earnings expectations by 2 cents – it reported a profit of $1.77 a share, after adjustments, versus an expectation of $1.79 a share. Although the share price rose 0.1 per cent to $70.15, Scotiabank trailed its four biggest peers.
So why warm to a cold bank?
The answer lies in a simple stock-picking strategy: Since lagging banks have an impressive track record of catching up with their big-bank peers relatively quickly, investors can score market-beating gains by scooping them up.
We’ve been tracking this strategy using data going back to 2000. Buying the prior year’s worst-performing bank stock and holding it for one year has produced an average annual return of 17 per cent (not including dividends).
That’s better than the 11-per-cent average return you would get from holding all of the biggest five bank stocks over the same period. And it’s much better than the 5-per-cent average return for the S&P/TSX Composite Index.
The strategy has delivered peer-beating returns 69 per cent of the time, and it has beaten the broad index 75 per cent of the time, which is a compelling record.
Although buying Scotiabank in 2015 was the most recent misfire (the stock trailed its peers by 5 percentage points that year), the strategy has worked well in the past few years. Buying Scotiabank again in 2016 and Canadian Imperial Bank of Commerce in 2017 produced peer-beating returns.
This year looks good too, relatively speaking. Yes, Bank of Montreal, last year’s laggard and this year’s pick, is down 2.6 per cent year-to-date. But the stock is outperforming its peers by 3.7 percentage points and is beating the S&P/TSX Composite Index by more than 5 percentage points.
Indeed, BMO is the second-best bank stock this year, and it is just 0.4 percentage points behind first-place TD.
Which brings us back to Scotiabank. The stock looks set to end the year as the laggard in 2018 and the top pick for 2019, making the list for the third time in five years.
All Canadian bank stocks have been struggling this year for a number of reasons. Rising interest rates are making bonds look more attractive next to dividend-paying stocks, the mortgage market is slowing, and low oil prices are threatening the Canadian economy and raising questions about whether bank loans to the energy sector will be repaid in full.
As well, Scotiabank has issues of its own. The bank has considerable exposure to Mexico, Colombia, Chile and Peru, but emerging markets have fallen out of favour with investors this year amid concerns over trade tariffs, falling commodity prices and rising U.S. interest rates.
More importantly, the bank has been on a $7-billion acquisition binge over the past 12 months – including its US$2.2-billion deal for BBVA Chile last November, when Scotiabank’s share price was near a record high. The weaker share price since then may be reflecting concerns over whether its acquisitions will pay off.
Betting on successful integration is a tough one for most investors to get right. Add to that the complexities of commodity prices, monetary policy and – most problematic of all – a coherent trade strategy from the U.S. White House, and you can be forgiven for nursing some uncertainty over bank stocks.
But Scotiabank shares now yield more than 4.8 per cent, the highest dividend payout of the biggest five banks. And they trade at just 9.5-times estimated earnings, according to Bloomberg, which is a cheaper valuation than all but CIBC.
Put another way, there is a wide gap between Scotiabank and its peers. Over the next year, the bank will probably close it.