After Canada’s Big 6 banks underperformed the broader TSX composite in 2022 for the fourth time in the past five years, Canaccord Genuity analyst Scott Chan laid out a pair of investment strategies for the sector in a research report released Wednesday titled Dogs of the Banks. “We took our title from the ‘Dogs of the Dow,’ which has been a successful longterm investment strategy that overweights the highest dividend-yielding stocks of the Dow Jones Industrial Average (DJIA) at the start of each year,” he said..” Historically, the Big-6 banks have offered low variance on investment returns. As a result, we look at a variation of the above approach: (1) Buy / Overweight the Bank that underperformed most in the preceding calendar year; and (2) Sell / Underweight the Bank that outperformed most in the preceding calendar year. In both cases (see Fig. 3 & 4), we determined that this investment approach added strong relative share performance vs. the Big-6 banks average. The investment strategy for 2023 would suggest to overweight Bank of Nova Scotia (BNS | BUY | negative 25.9-per-cent price return in 2022) and underweight Royal Bank (RY | BUY | negative 5.2-per-cent return in 2022).”
His first strategy focuses on Bank of Nova Scotia, which trailed its peers in 2022.
“We list the annual price return of the ‘worst’ performing bank stock the following year and compare it to peers,” he said. “We found that the average return of holding this bank the next year was 13.5 per cent and compared favorably to the Big-6 average return of 10.5 per cent, generating average annual alpha of 3.0 per cent. The strategy outperformed the peer average in 22 of 37 years, or 59 per cent of the time. For 2022, this investment strategy would have been to overweight RY (worst performing stock in 2021). This was successful as RY returned negative 5.2 per cent vs. the Big-6 average of negative 13.6-per-cent (plus 8.4-per-cent alpha). In 2022, BNS trailed peers with a stock price return of negative 25.9 per cent with this strategy to overweight BNS shares for 2023.”
Conversely, Mr. Chan’s second suggestion focuses on top-performer Royal Bank of Canada.
“We found that the average return of holding this bank the next year was 8.6 per cent, which underperformed the Big-6 average of 10.5 per cent, generating excess return of 1.9 per cent,” he said. “Since 1999, this approach worked 14 of 24 years, or 58 per cent of the time. For 2022, this strategy would have called to underweight BMO (best-performing bank in 2021), which was not successful as BMO generated a price return of negative 9.9 per cent vs the Big-6 average of negative 13.6 per cent (negative 3.7 per cent alpha). Last year, RY was the best-performing bank with a price return of negative 5.2 per cent. This investment strategy would be to underweight RY shares in 2023.”
He maintained his ratings and target prices for the banks’ stocks. They are:
- Bank of Montreal “buy” with a $151 target.
- Bank of Nova Scotia “buy” with a $81.50 target.
- Canadian Imperial Bank of Commerce "hold" with a $66.50 target.
- National Bank of Canada “hold” with a $101.50 target.
- Royal Bank of Canada “hold” with a $136 target.
- Toronto-Dominion Bank “buy” with a $103 target.