A stock falling a lot doesn’t necessarily mean it’s cheap and a buy. In the case of dividend stocks, a lower stock price means a higher dividend yield and more income for investors – given the dividend is sustainable and isn’t expected to be cut. And, of course, you should also expect the business to turn around within a reasonable timeframe.
Bank of Nova Scotia (TSX:BNS) stock peaked at approximately $82.50 per share in 2022. Since then, the big dividend stock has come off meaningfully. At $65.53 per share at writing, it is 20% lower than its 2022 peak and offers an eye-popping dividend yield of close to 6.5%.
A stock that acts like a GIC
This is a perfect perpetual income-generating opportunity for long-term investors. The risk-free one-year guaranteed investment certificate (GIC) offers an interest rate of about 5%. It is risk-free in the sense that it provides principal protection.
The same investment in Bank of Nova Scotia common shares offers about 30% more income, plus future income growth potential. However, investors are taking the risk of the underlying business as well as enduring the stock volatility that comes with it.
Risk vs rewards
In recent years, the international bank’s earnings have been more of a rollercoaster ride than for its peers, which is why the stock hasn’t performed as well. This is where the income opportunity comes in, as investors could very well park some money in the stock for juicy income.
For example, during the pandemic in fiscal 2020 year, Bank of Nova Scotia experienced an earnings-per-share (EPS) drop of 21% compared to the other Big Six Canadian bank’s EPS decline average of almost 15%. (If you’re curious, the most resilient of the Big Six was National Bank of Canada.).
Bank of Nova Scotia has riskier assets, given that a good portion of its operations are in developing markets that could experience higher growth but also have higher risk. These markets generally have higher levels of bad loans, especially during economic downturns. In a world of higher interest rates, the BNS stock price momentum remains weak.
A big dividend
So, the focus on the stock remains its big dividend. Its trailing-12-month payout ratio is about 74% of earnings. Based on adjusted earnings, its payout ratio is estimated to be about 65% this year. Its dividend is still covered by earnings, but since the normal payout ratio should be about 50% for the big Canadian banks, the bank might decide to freeze its dividend temporarily. This would be a hard decision to make and would depend on when management expects to see a resumption of growth.
Investors could view BNS stock similar to a “GIC”. With a long-term investment horizon, it’s hard to lose money from a decline in the stock price seeing as the stock trades at a very reasonable price-to-earnings ratio of about 10 today. Its long-term normal multiple is close to 11.
Assuming a conservative EPS growth rate of 5% per year and some valuation expansion to 10.5 times, the stock could still deliver roughly 12% per year over the next five years with more than half of the returns coming from its safe dividend. That would be a solid return for a blue chip stock and why I think long-term investors should consider BNS stock for their diversified portfolios.
