The Canadian bank stocks have underperformed the market in the last 12 months. As a proxy, BMO Equal Weight Banks Index ETF, which roughly consists of equal weight positions of about 16-17% of the fund in each of the Big Six Canadian bank stocks, has declined close to 12% in the period versus the Canadian stock market, which was essentially flat.
XIU, BNS, and ZEB 1-year data by YCharts
Bank of Nova Scotia (TSX:BNS) stock is down by a similar percentage as the ZEB exchange-traded fund (ETF). However, when dividends (or cash distributions for the ETFs) are accounted for, Bank of Nova Scotia has performed a bit better than ZEB.
XIU, BNS, and ZEB 1-year Total Return Level data by YCharts
Investors can make money from stocks by booking price gains or receiving dividends. Since the Scotiabank stock price has declined, it now offers an enormous dividend yield of about 7.2%. Assuming the dividend is safe, with little price appreciation, investors could get market-beating returns. (For your reference, the 10-year market rate of return is about 7.5%.)
Just because a stock’s price is down and offers a big dividend doesn’t mean investors should jump into the stock right away. To be cautious, further investigation is required.
Is Scotiabank stock’s 7.2% dividend safe?
Bank of Nova Scotia has paid dividends every year since 1833. Its 15-year dividend-growth rate is 5.3%, despite freezing its dividend in fiscal 2010 around the global financial crisis and in fiscal 2021 around the global pandemic. These are periods of higher risks in the economy. To be cautious, at these times of higher economic uncertainty, the regulator, Office of the Superintendent of Financial Institutions (OSFI), would request Scotiabank and other federally regulated financial institutions to halt dividend increases and stock buybacks to improve the stability of our financial system.
For further reference, BNS stock’s five- and 10-year dividend-growth rates were about 5% and 5.8%, respectively. In the past 10 fiscal years, the bank increased its adjusted earnings per share by close to 5.9% per year, which indicates healthy dividend growth backed by earnings growth.
The higher loan-loss provision this year that weighs on earnings has resulted in Scotiabank’s higher trailing 12-month payout ratio of about 70% of net income available to common shareholders.
BNS is a value stock
In the last reported quarter, Scotibank’s loan-loss provision was $819 million (up from $412 million in the prior-year quarter). To put it in more perspective, its fiscal year-to-date loan-loss provision (as a percentage of average net loans and acceptances) was 0.37% versus 0.16% a year ago. As well, its third-quarter net impaired loans (as a percentage of loans and acceptances) was 0.47% versus 0.36%. This cuts into its earnings, but it still maintains profits that cover its dividend with a cushion.
At $58.63 per share at writing, the dividend stock trades at roughly 8.3 times adjusted earnings. When risks are lowered or the economy improves, the bank would lower its loan-loss provisions, which would bump up its earnings. At that time, the bank stock valuation could expand, driving price appreciation of about 33%. Earnings growth could lead to more price appreciation.
BNS stock is a good buy at current levels, especially for income investors seeking outsized dividends. Long-term investors will enjoy juicy income and likely get decent price appreciation over the next five years.
