When it comes to gigantic financial institutions, investors are often falsely confident that they’re able to pick the highest quality of companies.
As an example, let’s look at the U.S. banking system a decade ago. Both Citigroup and Bank of America were riding high after years of consistent double-digit returns and large, growing dividends. These banks were lauded for everything from high-quality management to somehow finding a way to underwrite millions of mortgages per year better than competitors.
We all know how that ended.
Some investors in Canada’s banks are guilty of the same sins. Toronto-Dominion Bank has been the best performing Canadian bank in the past five years, mostly thanks to its expansion to the U.S. and its innovative approach to retail banking in Canada. But is this the beginning of a sustainable competitive advantage that can last decades? Or is today’s strength going to be tomorrow’s weakness?
Instead of trying to answer those difficult questions, investors tend to ignore them completely to build their own narrative. They see that TD has performed well, and go searching for information that will confirm that fact. Once the information is in hand, they feel comfortable buying the stock. That’s fine, but perhaps that’s a backward way of investing.
Instead of looking backward, investors should look forward with the assumption that the cheapest bank stock will outperform. And I have an easy way to figure out which bank stock is the cheapest.
Investors should buy the bank with the highest yield.
Digging a little deeper
There are a lot of value metrics that we can look at, which differ in usefulness depending on the sector. For the banks, investors will commonly look at price-to-earnings ratios first, a snapshot of the company’s ability to generate earnings.
On the surface, CIBC’s price-to-earnings ratio comes in at 13.4, which is about the middle of the pack compared with its peers. But that number doesn’t tell the whole story, since CIBC reported a charge of more than $500 million after writing off goodwill and some loans associated with its subsidiary in the Caribbean back in the second quarter of last year.
Without those write-offs, CIBC would have earned $8.02 per share over the last twelve months, not $7.28 per share as reported. Thus, if you base the company’s P/E ratio on normalized earnings, we have a stock that’s trading at just 12.1 times earnings, which would put it as the cheapest among the so-called Big Five.
A weak outlook might be good
As Warren Buffett likes to say, you’ll pay a high price for a cheery consensus. Investors willing to overlook short-term issues could be setting themselves up for better long-term returns.
CIBC is currently struggling a bit for a couple of reasons, namely because of the hit it took from losing exclusive rights to the Aeroplan credit card, one of Canada’s most popular pieces of plastic. Additionally, as I already hinted, operations in the Caribbean aren’t exactly tip-top.
But these things have a way of working themselves out over time. CIBC has recently introduced a partnership with Tim Hortons, as the bank behind its branded credit card. Customers can earn free coffee and donuts with each swipe, which is beneficial to both Tim’s and CIBC.
CIBC is also positioning itself in the wealth management area, acquiring U.S.-based Atlantic Wealth, which has nearly $25 billion in assets under management. Sure, the market may be clamouring for more growth, but the company is starting to show its days of taking large risks are behind it.
Although I can’t be sure CIBC is a good buy, I like that the company is cheaper than its peers and pays a generous dividend. I also think its problems are temporary and fixable. For those three reasons, I think the stock would look good in just about every portfolio.
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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.
Fool contributor Nelson Smith has no position in any stocks mentioned. The Motley Fool owns shares of Bank of America and Citigroup Inc.