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TFSA Investors: Why Bank of Nova Scotia Is a Better Pick Than Bonds

Bank of Nova Scotia (TSX:BNS)(NYSE:BNS) is a fantastic dividend pick right now that is significantly undervalued and doesn’t present some of the same risks as some of the other stocks trading on the TSX.

As a TFSA investor myself, I want high-yielding stocks in this account, but I also want safety; when a market crash happens, I don’t want my hard-earned tax-free savings to be wiped out.

What should a TFSA investor do?

A TFSA investor must be wise and balance safety with high yield in order to avoid paying taxes on dividends as well as capital gains. In the case of bonds, I currently recommend short-term corporate bonds as opposed to government bonds or long-term bond funds.

In an environment where interest rates are at a floor, we can expect longer-term bonds to be a less favourable investment for the many years to come. Short-term bonds offer more safety but have a much lower yield, and this can be frustrating to investors, but there is a cure for those seeking a high yield to go with a margin of safety.

Bank of Nova Scotia is an undervalued bank with a very bountiful 4.2% dividend yield whose exposure expands beyond the Canadian borders. Bank of Nova Scotia can be considered Canada’s most international bank, as it has operations in emerging markets within Latin America. Such emerging markets offer a greater growth opportunities, but there are risks, as with any investment.

How would a housing meltdown affect Bank of Nova Scotia?

It’s a misconception that Bank of Nova Scotia will get wiped out if the Canadian housing market collapses. Mortgages are less than half of the bank’s loan portfolio; half of which are insured from a housing meltdown by the Canada Mortgage and Housing Corporation (CMHC).

If a housing correction did occur, as many expect it will, it will actually have a small impact to the bank’s bottom line compared to its peers, which are more exposed to the Canadian housing sector, such as Canadian Imperial Bank of Commerce.

If you’re a TFSA investor who wants to buy a high yielder and forget about it for many years, then Bank of Nova Scotia could be the stock you’re looking for. While it’s important to have exposure to bonds, overexposing yourself will hurt your long-term returns, especially if you’re a younger investor that is just getting started.

Bank of Nova Scotia currently trades at a 1.7 price-to-book and a 12.8 price-to-earnings. The price-to-book is slightly lower than its five-year historical average price-to-book value with its price-to-earnings ratio being relatively in line.

The stock is not a steal like it was earlier in the year, but it still presents a huge dividend yield that TFSA and dividend investors should feel comfortable holding for the long run. If a housing crash did happen, the stock might pull back slightly, but a rebound would shortly follow, and there’s little to no chance that the dividend would get cut considering how strong the bank’s risk-management strategy and balance sheet are.

 

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Fool contributor Joey Frenette has no position in any stocks mentioned.

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