Global financial markets are in turmoil, as the coronavirus continues to spread around the world and fears of a financial crisis grow. While the short-term outlook is poor and a recession is likely, investors would do well to heed the words of Warren Buffett, one of the greatest investors or all-time and ignore the headlines.
In his annual letter to Berkshire Hathaway shareholders, Buffett wrote that the fundamental long-term outlook for U.S. businesses hasn’t changed. For that reason, he stated that investors need to maintain a cool head and ignore short-term panic-inducing headlines, despite markets plunging to lows not seen since the 2008 Great Recession.
Profit from fear
While it may be difficult to do so, especially in an environment where the Dow Jones and the S&P/TSX Composite are down by 24% since the start of 2020, it is imperative to remain calm. This is because the secret to creating wealth and achieving your financial goals it to invest for the long term in quality, dividend-paying stocks and stick to your strategy, no matter how bad the short-term outlook appears.
That becomes clear when it is considered that Canada’s Big Six banks were hammered during the Great Recession, yet they pulled through in good shape and have delivered strong returns since then.
The sixth-largest lender, National Bank of Canada (TSX:NA), has delivered an outstanding 231% since March 2008, which is a compound annual growth rate (CAGR) of 10%. After losing a whopping 36% over the last month because of the market rout, National Bank appears very attractively valued, making now the time to buy.
Canada’s most profitable bank
There are a range of reasons for this, but key is that National Bank is Canada’s most profitable major bank, despite lacking the international exposure of its Big Five peers. A key measure of profitability is a bank’s return on equity (ROE), which essentially measures the return it can generate from the investment made by shareholders.
For the fiscal first quarter 2020, National Bank reported a stunning double-digit ROE of 18.3%, which was 1.1% greater than a year earlier and higher than the other major banks. This is despite National Bank lacking significant exposure to markets outside Canada, such as the U.S. and Latin America. It is the bank’s domestic focus, notably on Quebec, which has been a primary reason for its strong performance.
For the fiscal first quarter, National Bank reported an 8% year-over-year increase in revenue, that net income had expanded by 12%, and a 13% rise in diluted earnings per share. That solid performance, in what can be characterized as a difficult operating environment, was driven by the bank’s ongoing focus on improving the efficiency of its operations.
National Bank reported that its efficiency ratio, which measures how easily a bank turns its resources into revenue, fell by 1.5% to 53.6%. This important to note, because the lower the ratio, the more cost effectively a bank can generate earnings from its assets. National Bank’s continuing focus on cost management and digitizing its platform will drive greater efficiencies and hence profitability over the long term.
The sharp decline in National Bank’s value because of the market crash means that if you buy today, it is possible to lock in a juicy 5% dividend yield. That payment is sustainable, even if a recession occurs, because it has a conservative payout ratio of 42%.
Looking ahead
The short-term economic outlook appears poor. There is every likelihood that the rapid global spread of the coronavirus will trigger a worldwide recession. That doesn’t bode well for Canada’s banks over the short term.
Nonetheless, National Bank’s fundamentals including the quality of its credit portfolio and capital adequacy as strong, meaning that it will deliver considerable long-term value. That makes the latest pullback a reason to buy the bank today.
