When most Canadians think of investing in Canadian banks, they tend to think of the big ones, and with good reason. The big Canadian banks have delivered solid earnings and dividend growth for a number of years. But there are other banks in Canada that might just be worth looking into.
One interesting company is Equitable Group Inc. (TSX:EQB). Equitable is a Schedule I bank that serves as a savings bank as well as a commercial and individual mortgage lender. The company has a branchless banking model that operates entirely online. The branchless model helps Equitable save on costs, passing more earnings on to shareholders.
The bank is extremely cheap on a valuation basis compared to the larger banks. It is currently reading at a P/E of six, where most of the Canadian banks have multiples of 10-13 times earnings. It is also trading at a P/B of 0.9. Compare this to a large Canadian bank, such as Royal Bank of Canada (TSX:RY)(NYSE:RY), which trades at a P/E of over 11 and a P/B of two. Clearly, on a valuation basis, Equitable is the cheaper option.
It will be important in the coming quarters to keep an eye on its financials. At the moment, everything appears to be going well, with loan growth up 9% and book value increasing 16%. The company also indicated that investors should be ready for slower loan growth, as mortgage rules continue to impact the housing market. The company is looking to expand its commercial loan book to differentiate away from housing, and it increased its commercial portfolio by 6% over the same period.
Equitable’s dividend is very attractive given its strong dividend growth and low valuation. The bank’s dividend is not large at 1.7%, but its rate of growth is particularly appealing. The dividend grew by 17% over the past year — much higher than the larger Canadian banks’ dividends, which were growing at lower rates. The payout ratio is also remarkably low at 10% of earnings, meaning Equitable is likely safe, and that it will probably continue to raise its dividend in the future.
While Equitable seems to be a solid bank, there are some downsides. Equitable, for starters, is not as diversified as the larger banks, making it more susceptible to a Canadian economic downturn than other banks. However, a negative outlook often creates buying opportunities. Since the stock has been driven down by these fears, this may be a time to buy.
Its exposure to the Canadian housing market and the Canadian consumer will probably be the main reason you choose to own this company or not. Equitable grew its loan book by 7% over the last year, increasing its exposure. A year ago, the downside potential played out when investors sold Equitable to very low levels, so you should be cautious if you are concerned about Canadian debt and housing.
Whether you choose to buy Equitable or one of the larger Canadian banks really comes down to your outlook on the Canadian economy. The Canadian economy is currently strong, and if you believe that will continue, Equitable is a cheap, leveraged play that Canadian economic strength will continue. If you are worried about Canada, one of the larger banks may be a better choice for you.
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 Kris Knutson has no position in any of the stocks mentioned.