Why I’m buying Canadian banks when others are fearful
As Warren Buffett famously said, one of the secrets to investing success is “to be fearful when others are greedy and to be greedy only when others are fearful.”
Well, judging by the recent declines in Canadian bank stocks, many investors are fearful that the turmoil affecting some U.S. and European banks will soon spill over into Canada. So, in keeping with Mr. Buffett’s philosophy, today I’m going to indulge my greedy side.
I’ve decided to increase my holdings of three of the four Canadian banks in my model Yield Hog Dividend Growth Portfolio. Specifically, I’ve added five shares of Royal Bank of Canada five shares of Toronto-Dominion Bank, and 10 shares of Canadian Imperial Bank of Commerce . I didn’t add to my Bank of Montreal position because it was already the highest-weighted bank in the portfolio.
These purchases were executed at Monday’s closing prices and consumed $1,645.30 of the model dividend portfolio’s “cash” balance. The model portfolio uses virtual money, but I also own all of these banks personally. (View my latest model portfolio update online at tgam.ca/dividendportfolio.)
I’m buying banks on the dip for several reasons. First, our big banks are well-capitalized and enjoy oligopoly power in Canada, with dominant positions in deposit-taking, lending, investment banking, insurance and wealth management.
Unlike in the United States, where a small number of mid-sized banks failed when customers (many with deposits in excess of insured limits) lost confidence and rushed to take their money out, in Canada the odds of a similar bank run are remote.
“While deposits were flowing out of the U.S. banking system, even prior to the run on Silicon Valley Bank (SVB), deposits in Canada have shown steady growth. Also, the dominant market position of the big banks in Canada provides each with relative deposit stability,” Paul Holden, an analyst with CIBC Capital Markets, said in a recent note.
What’s more, SVB and fellow U.S. casualty Signature Bank – which had close relationships with the tech and crypto industries, respectively – experienced tremendous deposit growth during the pandemic. That made them vulnerable to withdrawals when those industries stumbled and the U.S. Federal Reserve began to hike interest rates aggressively.
By contrast, the U.S. subsidiaries of Canadian banks “did not experience near the same level of deposit growth and therefore are not as susceptible to a withdrawal of excess saving,” Mr. Holden said.
Another reason I’m adding to my bank positions is that the stocks have attractive valuations. The sector trades at an average multiple of about nine times’ estimated fiscal 2023 earnings, which is roughly a 13-per-cent discount compared with the second quarter of 2019, Scott Chan, an analyst with Canaccord Genuity, said in a recent note to clients. As a result, the dividend yield, which moves in the opposite direction to the price, has risen to an average of about 5 per cent. And that’s before an expected round of dividend increases when the banks report second-quarter results in May.
“For Q2 … we continue to anticipate slight dividend increases across all banks (except TD) with group average growth of about 3 per cent,” Mr. Chan said. (TD typically raises its dividend once a year when it announces fourth-quarter results, whereas other banks have been hiking their dividends semi-annually.)
That’s not to say the outlook for banks is entirely rosy.
With the economy slowing, consumers grappling with inflation and higher interest rates, and sectors such as housing and commercial real estate (especially offices) feeling the pinch, there are some clouds on the horizon.
Moreover, banks are dealing with their own internal issues. For TD, in particular, turmoil in the U.S. regional banking sector and regulatory delays are creating doubts about its proposed US$13.4-billion acquisition of U.S. lender First Horizon Corp. Shares of the Memphis-based bank, which has about 400 branches in the U.S. Southeast, are trading at a 29-per-cent discount to TD’s initial offering price of US$25 a share.
First Horizon’s lagging share price indicates that investors believe TD will attempt to negotiate a lower price or walk away from the deal entirely. The silver lining is that either of these outcomes would likely give TD’s share price a boost, given that investors are nervous about TD increasing its already significant U.S. exposure at a time when some U.S. regional banks are struggling.
Despite the short-term risks, I’m confident that Canadian banks will continue to do what they do best: post billions of dollars in profits every quarter and raise their dividends steadily. That’s why I’m listening to my greedy side while bank stocks are held back by fear.