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3 Reasons Why National Bank of Canada Is Poised to Outperform the Big 5

Over the last century, I don’t think there’s been an investment that’s combined the staying power, consistency, and solid returns of Canada’s banks. Every investor should have at least one of them in their portfolio.

But which one? Some are more expensive, like Royal Bank of Canada or Toronto-Dominion Bank, but they’re the two biggest financial institutions in the country. Both also have extensive foreign operations, a huge market share in domestic lending, and solid wealth management businesses as well. It’s no wonder they trade at a higher premium than the rest of the sector.

At the end of the day, there isn’t a whole lot of difference between any of Canada’s so-called “Big 5” banks. They all have diversified operations, with their fingers in everything from insurance to credit cards. They all have good asset bases, with significant exposure to foreign markets. All have capital markets operations on both sides of the border.

That is, with one exception — the often-forgotten large Canadian financial, National Bank of Canada (TSX: NA).

Compared to the Big 5, I think it’s a more interesting investment. Here are three reasons why I think you should add it to your portfolio.

1. It’s cheaper

Even though National Bank has outperformed its peers lately, it’s still the cheapest bank in Canada.

Shares trade at just 11.4 times earnings, and at less than 10.6 times estimated 2015 earnings. That’s almost 20% less than Royal Bank, and 10% less than the others in the Big 5.

No matter what metric you look at — whether it be price to book value, price to cash flow, or others — National Bank consistently is cheaper than its peers, even though it posts revenue and profit growth that outpaces them. I know that the larger banks have better brands, but just how much of a premium are you willing to pay for that consumer recognition?

2. Foreign potential

One of the reasons National Bank trades at a discount is because investors view it as very Quebec-centric. At some point, the company will join its peers and expand into foreign markets.

Right now, the company only has a token amount of exposure to foreign markets. Sure, there’s potential for it to further expand out of Quebec and further into other parts of Canada, but there are already different options for Canadians who don’t want to deal with one of the Big 5.

Instead, National should look at buying a small U.S. bank. Unlike Canada, the U.S. has thousands of small regional banks, some of which trade at very cheap valuations. But more importantly, it would diversify operations outside of Quebec, which should help boost the company’s valuation. Opening up new growth markets is good, no matter what the business.

3. The dividend

Thanks to the recent market sell-off, National Bank’s dividend yield is close to 4% again.

Compared to fixed income options, this is a great choice. Investors have flocked back into bonds as markets have plunged, which has pushed down yields once again. For income investors, most bonds just aren’t an option. They simply don’t pay enough.

Currently, the 10-year Government of Canada bond yields an pitiful 1.93%. Investors in National Bank aren’t just getting a dividend that’s twice as much as a long-term bond, but they also get the upside potential that comes with the stock. Even if the company can just trade at a P/E ratio in line with its peers, that represents an upside of 10-15%. That’s not too bad, especially in these uncertain markets.

Want to learn more about Canada’s banks? Check out the free report below.

Do you own bank shares? You won't want to miss our latest report!

Canadian banks are considered must-have investments. After all, they're very stable, well-capitalized, and face limited competition. That said, there are concerns for the banks and their investors. In this FREE report, we cover everything you need to know about Canada's Big 5 -- whether you're already an investor or are considering buying shares. Simply click here to receive your special FREE report, “What Every Bank Shareholder MUST Know."

Fool contributor Nelson Smith has no position in any stocks mentioned.

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