Bank of Nova Scotia (TSX:BNS)(NYSE:BNS) had a rough start to 2016, but the stock has staged an impressive turnaround in the back half of the year.
Let’s take a look at Canada’s third-largest bank to see if it deserves to be in your portfolio heading into 2017.
Oil exposure
Bank of Nova Scotia has higher direct exposure to oil and gas companies than its larger peers, and that’s a big reason why the stock was out of favour in early 2016.
In fact, when WTI oil dropped below US$30 per barrel in January, Bank of Nova Scotia’s stock traded at a low not seen since 2013 and at a price-to-earnings multiple that would be expected during a financial crisis.
Savvy investors realized the pullback was overdone, and those who picked up the shares at the bottom are now enjoying a gain of better than 50% with the dividends included.
What happened?
Oil prices improved enough to allow most oil companies to stay solvent. This led to lower-than-expected loss provisions at Bank of Nova Scotia, and investors moved back into the stock.
As the year has progressed, the market has also realized Bank of Nova Scotia’s restructuring efforts are bearing fruit. The Canadian operations continue to post strong results, and the international investments are putting up impressive numbers.
How impressive?
Bank of Nova Scotia’s international operations generated more than $2 billion in earnings in fiscal 2016.
Enter Trump
The Trump election win has put a tailwind behind the entire banking sector, and Bank of Nova Scotia is now at an all-time high. At the time of writing, the stock is at $77 per share. Back in January, you could have picked it up for less than $52.
Can the rally continue in 2017?
OPEC’s agreement to reduce oil output is providing a nice lift to oil prices, and that should remove any concern regarding Bank of Nova Scotia’s energy loans, as long as the positive mood continues.
However, if the market starts to sense OPEC and its peers are cheating on the deal, oil could reverse course, and that would potentially hit the stock.
What about housing?
House prices are likely to be the main focus in 2017. Bank of Nova Scotia finished fiscal Q4 2016 with $193 billion in residential mortgages on the books. Insured loans represent 57% of the portfolio and the loan-to-value ratio on the remaining portion is 50%.
This means house prices would have to fall significantly before the bank takes a material hit.
If the market starts to sense housing has topped out, bank stocks could come under pressure, and that would likely provide a nice opportunity to buy.
Should you buy today?
Bank of Nova Scotia is a solid long-term pick and deserves to be in any buy-and-hold portfolio. The dividend is safe, and the international operations provide a nice hedge against potential trouble in Canada.
Having said that, the stock has gone from being priced for disaster at the start of the year to priced for perfection today.
The broader market is due for a healthy correction, and Canadian housing concerns could start to creep up in the first part of next year. As such, I would wait for a pullback before buying this stock.
