Canadian Banks: Just Say Yes

Canada’s six largest banks announced earnings this week, and the Twittersphere was abuzz with investors’ latest opinions on these behemoths.

Two banks were singled out for their disappointing numbers, each for different reasons. The first was Bank of Nova Scotia (TSX:BNS), which ended up holding firm on its dividend. The market, naturally, expected a bit of a boost in BNS’s payout. This issue was exasperated when every other major bank ended up raising their dividends.

Secondly, CIBC (TSX:CM) also posted a disappointing quarter. Nearly every relevant metric came up short of expectations, including revenue, earnings, loss reserves, return on equity, and the look of the CEO’s face.

Okay, I made the last one up. But you probably believed me for a second. That’s how bad CIBC’s quarter was.

Then, on Friday, CIBC got more bad news. The bank was found liable in a lawsuit launched by Cerberus over a 2008 limited recourse note it used to invest in one of Cerberus’s funds. The full amount of the lawsuit was more than US$1 billion, although that amount will potentially come down during a December 19th hearing that will determine CIBC’s total liability.

The bank told investors Friday it will take a non-specified charge to cover the lawsuit next quarter, and shares tanked some 8% on the news.

Both Bank of Nova Scotia and CIBC have underperformed peers for years now. Here’s a quick snapshot of the six largest Canadian bank returns from Dec 4th 2017 to Dec 4th, 2022:

The difference is striking. Scotiabank shares went backwards over the last five years; the dividend was the only saving grace. CIBC shares did marginally better, but lagged the rest of the group pretty substantially. National Bank was the big winner as the company rode strategic growth opportunities and Quebec’s economic expansion to the top spot.

The problem is bank investors (hell, all investors) have short memories, and they’re more likely to put their capital into the bank(s) that have recently outperformed their peers. That might be a fine short-term strategy, but is it a winner over the long-term?

I don’t think so, and to illustrate let me take you back to 2002 and another Canadian bank that was in crisis mode.

Let’s go back to 2002

In 2002 Nelson was firmly in his first real job working night crew at a grocery store, a job chosen because it paid $10 per hour instead of the prevailing $8 per hour wage that was commonplace. I still lived in my parents’ basement and was absorbing hours of ROBtv (later BNN) to quench my stock market thirst.

TD Bank (TSX:TD) caught my attention as I watched. The bank had a number of different issues, including horrific capital markets results (thanks, imploding tech bubble), a big acquisition that wasn’t living up to expectations, and weak results from the wealth management part of the business. 2002 was such a bad year the company went out of its way to mention how bad it was in its annual report that year.

As you can see below, profits absolutely collapsed in 2002.

(Aside: I love reading old annual reports. You can really see if management did what they promised with the benefit of hindsight. It can be incredibly useful if the same people are in charge)

Naturally, TD shares slumped on this news. On a split-adjusted basis, TD started off 2002 trading at $21.30 per share. By September the stock had slumped all the way to $13.89, or about a 40% decline. Royal Bank, in comparison, was up about 5% during the same period.

Investors who had the intestinal fortitude to buy TD shares in December, 2002 (a date I’m using because it was conveniently 20 years ago) did extremely well. Despite all the bad news surrounding the stock, TD shares delivered a massive 12.79% CAGR over 20 years, enough to turn a $10,000 initial investment into something worth $111,132. Assuming you reinvested all your dividends, that is.

Your author did buy TD shares in late 2002, convinced the bank would recover. It was a winning strategy. The only problem is I sold sometime in 2004 and put my cash into some other investment that was likely much worse than simply holding onto TD. Whoops.

I know past performance is no guarantee of future results. And I also know the problems facing Scotiabank and CIBC are different than what plagued TD so many years ago. But here are the return profiles of each large Canadian bank over the last 20 years, and there’s little doubt TD did well because investors bought at an opportune time.

The lessons

There are legitimate reasons not to like BNS and CM shares today. I get it. But to outperform, you must look at more than the next six or 12 months. And you also must be willing to buy when things look darkest.

There’s an interesting wrinkle to my backtest. Generally, buying the bank that has underperformed its peers was a surefire way to outperform during the next five years. But Scotiabank has been bad long enough it’s really putting that theory to the test. I continue to be bullish, but I’m overweight enough I think my next purchase will be another bank that has underperformed lately, likely CIBC with all of its recent troubles. I don’t need to really overweight Scotiabank. A slight overweight (like I have now) will do.

But the real point I want to make with this post is as follows. Over the last 20 years, Canada’s banks have been really solid investments. They survived the terrible bear markets of the early 00s, the Great Recession of 2008-09, Canada’s oil patch essentially collapsing, COVID, and, finally, the next upcoming recession. Presumably, anyway. Despite all that, they performed well, grew dividends, and expanded into new markets. Even if you picked the worst one and held it, you still grew your money at nearly 10% annualized.

The important part isn’t investing in the right Canadian bank. Investors get ahead by investing in all of them. Stop trying to pick a favorite and just buy them all. Or, if you must, slightly overweight your favorite and make sure you have plenty of exposure to the rest.

A simple equal-weighted bank portfolio today gets you nearly a 5% yield, good capital gains potential, and exposure to some of the best financial institutions in the world. You’ll get dividend growth likely a bit faster than inflation and payout security that simply can’t be beat. And if that’s not enough, you also get an implicit government guarantee that your investment will be protected during tough times.

ETFs exist that can build an equal-weighted bank portfolio for you, but I’d avoid them. They charge approximately 0.5% each year to rebalance six stocks, something a retail investor can easily do with yearly contributions. There’s also benefit to letting the top performer ride, something you’ll lose if an ETF is rebalancing on a regular basis.

And for God’s sake, buy National Bank too. That bad boy has only outperformed over the last five, ten, and 20 years. They must be doing something right.

Author has positions in each of the six largest Canadian banks, with a slight overexposure to Scotiabank. There are no plans to sell a single share anytime soon. Next purchase in the sector will likely be CIBC.