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Regional Banks or Canada’s Big Five Banks: Which One Is the Better Buy?

The bears have taken over. Canada’s financial system is once again under attack and shorts are targeting Canada’s Big Five banks.

Why now? It seems to be usual practice as of late. Over the past number of years, at least once a year bears come out in full force against Canada’s banks.

The reasons to short aren’t novel ideas. Bears point to Canada’s worsening economic conditions and weakening housing market as reasons to short the banks; it’s the same story that investors have heard year over year. Yet, Canada’s Big Banks continue to deliver record earnings underpinned by a healthy and rising dividend.

That said, given that the Big Five have been singled out, perhaps it’s time for investors to look at the smaller regional banks. From a valuation perspective, there are no cheaper banks that Canadian Western Bank (TSX:CWB) and Laurentian Bank of Canada (TSX:LB).

Similar returns

Since the start of 2019, Canadian Western and Laurentian have performed inline with Canada’s big banks. They have each returned close to 9% year to date and have outperformed the Bank of Nova Scotia (TSX:BNS)(NYSE:BNS) and Canadian Imperial Bank of Commerce (TSX:CM)(NYSE:CM).

Up until March, Laurentian was the top performing of the group and Canadian Western was a close second. Laurentian’s fall was due in large part to difficult quarterly earnings, while Canadian Western has been under pressure as oil prices declined.

However, thanks to recent price weakness, they are now the best valued bank stocks on the TSX.

Stocks with cheap calcuations

First, let’s start with Laurentian Bank. Laurentian’s struggles have been well documented. However, the company recently settled on a new collective agreement with its unionized employees. As North America’s only unionized bank, this has been an overhang on the company for more than a year. Now that this has been settled, all that remains is to execute on the company’s digital transformation.

For contrarian investors, Laurentian looks attractive. It currently trades at a cheap 9.02 times earnings at 8.39 times forward earnings. Likewise, it has an industry low price-to-book (P/B) ratio of 0.77 and a Graham number of $74.30. The Graham number was made famous by the father of value investing Benjamin Graham. The Graham number represents the fair value of a stock and the maximum one should pay. As of writing, Laurentian bank is 80% undervalued as compared to its fair value.

Canadian Western is similarly cheap, with a P/E of 9.91 and a forward P/E of 8.19. Its P/B ratio of 1.03 is below industry averages and it has a Graham number of $43.19, which implies 52% upside from today’s price.

Foolish takeaway

Canada’s Big Banks will always command attention. However, some of the smaller, regional banks offer better value and the potential for outsized returns. Laurentian Bank and Canadian Western Bank make excellent contrarian picks at today’s valuations. It is also worth noting that they are both Canadian Dividend Aristocrats with a long and storied history of raising dividends that are well covered by earnings.

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Fool contributor mlitalien has no position in any of the stocks mentioned. Bank of Nova Scotia is a recommendation of Stock Advisor Canada.

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