Contents

The Big 5 Canadian Banks

 

The Big 5 Canadian Banks have a track record of rewarding long-term investors despite continually changing industry, business, and economic environments.

Summary

  • The Big 5 Canadian banks have recently released their Q1 2019 results and have reiterated that business conditions are challenging.
  • Short sellers who have renewed their Big 5 bets in early 2019 are currently paying a high price following the rapid increase in share prices subsequent to mid-December lows.
  • The Big 5 are currently reasonably valued and represent solid investments for investors with a long-term investment time horizon and who desire an increasing stream of dividend income.

Introduction

NOTE: The Big 5 Schedule 1 Canadian Banks are listed on the TSX and NYSE. All figures reflected in this article are in CDN $ and I have used the March 8, 2019 closing share prices.

The following Big 5 Schedule 1 banks in Canada have long been a favorite investment for many investors seeking safety, income, and growth.

  • The Bank of Montreal (BMO)
  • The Bank of Nova Scotia (BNS)
  • The Canadian Imperial Bank of Commerce (CM)
  • The Royal Bank of Canada (RY)
  • The Toronto-Dominion Bank (TD)

I have written articles in which I have focused exclusively on one Schedule 1 bank. This article, however, touches upon all 5.

My reason for writing this article is that:

  • They all recently released their Q1 2019 results while I was on vacation;
  • In my A Great Investment Portfolio Example of Diversification article I disclosed that the value of my Big 5 holdings make up ~16.4% of my total holdings. I, naturally, take a great deal of interest in what is happening with these banks.

Before going further, I recognize some readers may find my exposure to this industry to be somewhat excessive. If so, consider a Financial Freedom is a Journey subscriber who is a former senior executive of one of the Big 5, holds in excess of 45% of his total equity investments in one of the Big 5! A condition of his appointment at the bank was a requirement to hold 3 times his salary in common shares; this was separate from option grants.

In the years he served with the bank, the option grants were quite generous. He bought some of them to hold and used the gain on some of them to buy the options. While capital growth is something for his children to appreciate, dividend income is now his/his wife’s dominant source of retirement income.

This subscriber’s 2nd largest holding? Another of the Big 5 which constitutes ~5.67% of his overall portfolio.

I fully appreciate not everyone reading this would feel comfortable with these levels of portfolio concentration and would counter with the argument that it is important to spread your money across a variety of stocks or asset classes to protect yourself from risk. Heck, I have stumbled across a blog where the writer discloses a portfolio value of a few hundred thousand dollars scattered over 100+ stocks! This strikes me as throwing mud against the wall.

I am not here to disparage another’s investment style but I draw to your attention the following:

“Behold, the fool saith, 'Put not all thine eggs in the one basket.' 'Scatter your money and your attention'. The wise man, however, says "Put all your eggs in the one basket and - WATCH THAT BASKET ."

― Mark Twain, Pudd'nhead Wilson

Some of the world's best investors talk about the virtues of holding concentrated positions. Warren Buffett, for example, is of the opinion that 'Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.'

I know my limitations and can categorically say that I could not possibly pay enough attention to a broad spectrum of stocks in a variety of industries and/or asset classes. As a result, ~16.4% of my overall investments is in companies in an industry in which I:

  • was employed throughout my career;
  • am interested;
  • am rewarded with a steadily increasing stream of dividend income;
  • have the opportunity to benefit from capital growth;
  • know risk mitigation is part of each bank’s DNA.

While the Big 5 have rewarded me extremely well, I am fully cognizant that stuff can happen so I pay attention to what could derail these banks. I, therefore, will never forget what happened to the global banking system during The Financial Crisis.

I distinctly remember that timeframe because I worked in an area of one of the Big 5 where we interacted with companies/banks within the financial sector on a global basis. Times were REALLY not good for foreign banks. In fact, times were not good for the Big 5. Relative to foreign banks, however, the Big 5 banks were a safe haven. Yes…the share prices tanked and they each froze their respective dividends but at least they didn’t slash their dividend and run to the government for financial assistance. THAT increased my comfort level in the Big 5.

Short-Selling Canadian Banks

Lately, short sellers have been increasing their short positions in the Big 5; details on short-selling activity are provided twice a month and data can be accessed at the Investment Industry Regulatory Organization of Canada website.

Subsequent to just before Christmas 2018, the share price of each of the Big 5 has been on an upward trajectory which suggests some short-sellers might not be faring so well with their calls.

Having said this, the banks face a number of headwinds and on the recent Q1 conference calls with analysts, senior management at each of the Big 5 indicated they ‘continue to see market volatility due to greater vulnerability to the macroeconomic outlook stemming from trade tensions, geopolitical uncertainty and revisions to global growth forecasts to the downside.’

With some unfavourable changes in near-term macroeconomic variables (eg. equity markets, oil prices, Brexit, US/China trade negotiations, unemployment rates, etc.) it would not surprise me if we witnessed a pull back in the share price of the Big 5 before mid-year. Short-sellers with deep pockets and the intestinal fortitude to stick with their positions will likely profit from their positions. (NOTE: I think there will be a broad market pullback within the next 6 – 12 months.)

Headwinds

I provide links to the Economic Research segment of each of the Big 5 where you can read their respective summary of recent economic events and what to expect in the weeks ahead.

As noted above, many Big 5 short-sellers have experienced challenges to date. I do not, however, think it is unreasonable for us to witness softer Big 5 stocks prices within the next 6 – 12 months as a result of:

Despite these short-term challenges, I am long-term bullish on the Big 5. I provide links to reasonably recent interviews conducted by a couple of the CEOs from the Big 5 I thought you might find to be of interest.

BNS CEO Brian Porter

RY CEO David McKay

Q1 2019 Results

I will not review the quarterly results for each of the Big 5 in this article. I do, however, provide links to each bank’s website where you can read about their Q1 2019 results and outlook for the remainder of the current fiscal year.

Credit Ratings

Far too often people invest while looking through rose colored glasses. In my opinion, I think it is extremely important to look at a company’s potential downside. As part of the exercise I look at a company’s credit ratings assigned by various major credit rating agencies.

Links to the credit ratings for each of the Big 5 are provided below.

In all cases, the credit ratings are investment grade and the outlook is stable or positive.

Valuation

The Big 5 have indicated they continue to face many of the same challenges and opportunities identified at the end of 2018. On this basis I anticipate that full-year performance for all 5 will likely be closer to the low end of their respective medium-term target for adjusted EPS growth (7 – 10% target range).

The calculations found below are based on consensus FY2019 adjusted EPS estimates from multiple analysts.

BMO

BMO’s forward adjusted PE of ~10.64 is based on the mean $9.67 adjusted EPS projection for FY2019 and the current $102.83 share price. The historical 5 year PE is ~12.5 which implies the current forward valuation is attractive to recent historical levels.

BNS

BNS’s forward adjusted PE of ~9.98 is based on the mean $7.24 adjusted EPS projection for FY2019 and the current $72.25 share price. The historical 5 year PE is ~11.8 which implies the current forward valuation is attractive to recent historical levels.

CM

CM’s forward adjusted PE of ~9.04 is based on the mean $12.37 adjusted EPS projection for FY2019 and the current $111.87 share price. The historical 5 year PE is ~10.8 which implies the current forward valuation is attractive to recent historical levels.

RY

RY’s forward adjusted PE of ~11.35 is based on the mean $9.06 adjusted EPS projection for FY2019 and the current $102.87 share price. The historical 5 year PE is ~12.6 which implies the current forward valuation is attractive to recent historical levels.

TD

TD’s forward adjusted PE of ~11.02 is based on the mean $6.79 adjusted EPS projection for FY2019 and the current $74.83 share price. The historical 5 year PE is ~13.4 which implies the current forward valuation is attractive to recent historical levels.

Historical Returns Comparison

While the past certainly does not predict the future I still like to look at how a company has performed over the long-term. If this is also of interest to you then go to this website wherein you can compare returns for the Big 5 over various timeframes. In the ‘other field’ you can insert the stock symbol for 2 banks separated by a comma. The results will show how the banks have fared with and without dividend reinvestment.

When you look at how the banks have performed relative to each other over the past decade it is clear why TD commands a higher PE.

Dividend and Dividend Yield

With the exception of TD, all have increased their quarterly dividend twice a year for the past several years; TD increases its dividend annually.

  • BMO – $1.00 quarterly dividend represents a ~4.17% increase from previous $0.96 quarterly dividend. On the basis of the current $102.83 share price this provides investors with a ~3.89% dividend yield.
  • BNS – quarterly dividend recently increased ~2.35% from $0.85 to $0.87. On the basis of the current $72.25 share price this provides investors with a ~4.82% dividend yield.
  • CM – quarterly dividend recently increased ~2.94% from $1.36 to $1.40. On the basis of the current $111.87 share price this provides investors with a ~5% dividend yield.
  • RY – quarterly dividend recently increased ~4.08% from $0.98 to $1.02. On the basis of the current $102.87 share price this provides investors with a ~3.97% dividend yield.
  • TD  – quarterly dividend recently increased ~10.45% from $0.67 to $0.74. On the basis of the current $74.83 share price this provides investors with a ~3.96% dividend yield.

Final Thoughts

There is no denying the Big 5 face headwinds and same has been communicated by senior management in recent quarterly conference calls.

If you, however, are investing for the long-term I am reasonably confident that your investment in any of the Big 5 will be rewarding. This is why I have had exposure to members of the Big 5 going back to 1987.

I have periodically added to my positions and have reinvested a significant portion of all dividends. In fact, I acquired another 500 shares in each of BMO and CM on December 4, 2018 for the FFJ Portfolio and a couple hundred more shares in each of RY and TD for undisclosed accounts just prior to Christmas 2018.

I am not implying the Big 5 will experience the same degree of growth as some ‘high octane’ companies but extreme growth is not something you should even expect from your investment in the Big 5.

In my opinion, you should expect a reasonable level of capital growth and a steadily increasing stream of dividend income. These rewards are certainly acceptable from my perspective considering investments in the Big 5 should enable you to sleep well at night despite continually changing industry, business, and economic conditions.

I wish you much success on your journey to financial freedom.

Thanks for reading!

Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].

Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation. 

Disclosure: I am long BMO, BNS, CM, RY, and TD.

I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.