ALERT: Avoid This 1 Bank Stock!

National Bank of Canada is trading significantly above intrinsic value. I would avoid the stock in your TFSA and RRSP.

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National Bank (TSX:NA) is a chartered bank under Schedule 1 of the Bank Act (Canada). It offers a wide array of financials services throughout Canada and select services around the world.

It operates four business segments – personal and commercial banking, wealth management, financial markets, and the U.S. specialty finance and international segment. It offers banking and investing solutions for individuals and businesses, corporate banking and investment banking services, securities brokerage, insurance, and wealth management.

The company reports a market capitalization of $23.90 billion with a 52-week low of $55.44 and a 52-week high of $73.22.

Intrinsic price

Based on my calculations, using a comparable company analysis (CCA) model, I determined that National Bank has an intrinsic value of $52.06 per share.

At the current share price of $71.50 at writing, I believe National Bank is substantially overvalued. I think that investors looking to add a bank stock to their TFSA or RRSP should not buy National Bank. Other bank stocks provide a better opportunity for capital gains.

National Bank has an enterprise value of $22.2 billion, which represents the theoretical price a buyer would pay for all of National Bank’s outstanding shares plus its debt.

Financial highlights

For the fiscal year ended October 31, 2019, the company reported a strong balance sheet with retained earnings of $9.3 billion, up from $8.5 billion in 2018. This is a good sign for investors as it indicates previous year surpluses have been reinvested in the company’s growth.

Given shareholders’ equity of $15.1 billion, intangibles of $1.4 billion, and goodwill of $1.4 billion, the company reports tangible net worth (equity minus goodwill and intangibles) of $6.5 billion. Tangible net worth refers to the real value of a company.

Unlike some of the other banks that experienced a double-digit increase in its provisions for credit losses, National Bank increased its allowance for credit losses to $678 million, from $658 million in 2018 (+3%). This suggests that it is somewhat insulated from expected defaults in the domestic market.

The company reports total revenues of $7.1 billion in 2019, up from $6.8 billion in 2018 (+3.6%), offset by an increase in expenses for pre-tax income of $2.8 billion. The company ended the year with relatively flat net income at $2.3 billion, up from $2.2 billion in 2018 (+4%).

From a cash flow perspective, management has a normal course issuer bid (NCIB) in place whereby it purchased and cancelled $281 million of common shares, down from $467 million in 2018.

National Bank is a dividend-paying entity with a dividend yield of 3.97%, which is achieved through quarterly payments of $0.71 per share. Dividends paid represents a significant portion of cash outflows at $992 million in 2019 and $918 million in 2018.

Foolish takeaway

Investors looking to buy shares of a bank should avoid National Bank. Despite the company’s positive retained earnings, continued profitability, and normal course issuer bid, the company is trading at $71.50, which is above its intrinsic value of $52.06.

This is driven by an enterprise-value-to-revenue (EV/R) ratio that is higher than the median for banks. National Bank reports an EV/R ratio of 4.0 times in fiscal 2018 and 4.4 times in fiscal 2017, compared to the median of 3.3 times and 3.1 times for those years.

RRSP and TFSA investors looking to buy shares of a bank stock should look at other companies with EV/R ratios of less than the median.

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 Chen Liu has no position in any of the stocks mentioned.

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