3 Reasons Why National Bank of Canada Is My Top Canadian Bank Pick

The market continues to undervalue National Bank of Canada (TSX:NA), and for no good reason.

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It’s difficult sometimes to pick a favorite Canadian bank.

Each has its own set of pros and cons. For instance, let’s look at Toronto-Dominion Bank (TSX: TD)(NYSE: TD). It continues to deliver terrific results, especially from its Canadian retail operations. It’s grown to be Canada’s largest mortgage lender, and led the way with opening branches on the weekend. It also has terrific U.S. assets, which continue to grow nicely.

The problem? It’s expensive. At more than 14 times earnings, shares are the most expensive of Canada’s banks. Investors are getting a quality company when they buy TD, but is the company worth the extra premium?

Perhaps, but I’m more of a fan of National Bank of Canada (TSX: NA). Here are three reasons why it continues to be my favorite in the sector.

1. It’s cheap

Over the last month, shares of National Bank have surged, rising almost 10%. Even after the jump, the company still trades at a reasonable valuation.

Shares currently trade at 12.3 times earnings, still among the cheapest in the sector. It also trades at a reasonable 1.9 times book value, 2.3 times sales, and 9.6 times cash flow. It’s the cheapest bank in the country by all these metrics, too.

You could argue that National is cheap for a reason, like its overexposure to Quebec, which is looking economically weak. But like I mentioned above, every bank has some sort of negative going for it. I would much rather deal with National’s question marks than pay a 20% higher valuation to buy TD.

2. Expansion opportunities

Another reason why analysts say National Bank is cheaper than its competitors is its Canadian-centric operations. Unlike the rest of the sector, it doesn’t have meaningful operations outside of Canada.

I can’t say when, but I’m certain that will change. The company’s management is hearing the same things we are, and is likely looking to acquire assets outside of the country. The United States is always a popular choice, but other banks have expanded into other areas like the Caribbean, Latin America, and Asia.

There are plenty of small banks around the world for National’s management to look at acquiring. Once it starts to dip its toe outside of Canada, look for the valuation gap between it and its peers start to decrease, which should lead to further upside.

3. A generous dividend

Thanks to the recent run-up of its shares, National Bank doesn’t boast the highest dividend yield of its peers any longer. That title goes to CIBC and its 3.75% yield.

National’s yield is still generous, though, at 3.58%. Not only does it have a fantastic history of raising the dividend, but it also has a great payout ratio of approximately 40%. Thanks to that generous dividend, all shares have to do is increase 6.4% annually for investors to get a 10% annual return, which is certainly achievable over the long term.

I’m not sure if I’d buy National Bank at these levels or wait for it to retreat a little, but it continues to be my favorite stock among Canada’s banks. It’s cheaper than its peers, has an easily identifiable potential catalyst, and gives investors a pretty generous yield with good growth potential. Eventually, the market will value it in line with its competitors, which gives it a little better upside potential than the rest.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

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