Recession Risk: Avoid These 2 Financial Stocks for Now

Right now, it is a good idea to stick to the larger, more diversified Canadian banks.

| More on:
Red siren flashing

Image source: Getty Images.

I am a big fan of owning the Big Five Canadian banks as long-term holds. In spite of the challenges they will face regarding an economic recession, a possible housing crisis, and the second major collapse in oil prices in less than a decade, these stocks are solid. Unfortunately, I would not extend that same leeway to every financial institution in Canada.

Financial risks

I would not, for example, buy goeasy (TSX:GSY) or Equitable Bank (TSXEQB) today. These financial institutions are far more exposed to the weak Canadian consumer than the large Canadian banks. The Big Five Canadian banks have much more diversified businesses than these smaller financial institutions.

Growth rates have been huge

Both of these companies have had huge growth rates over the past several years. goeasy, for example, saw its loan portfolio increase by 33% year over year, leading to a 20% increase in revenue. Adjusted annual earnings per share increased by 45%.

All of these impressive numbers allowed the company to increase its dividend by 45% as well. This gives investors a dividend yield of about 5% at the current share price.

Equitable also had substantial results in 2019. Its annual adjusted earnings per share were up 22% year over year — a record number for the company. Equitable’s deposits were up by 13% from year-end 2018. The company raised its annual dividend by 23%, resulting in a 2.44% yield at the current market price.

Then why be concerned?

The positive results were very encouraging when they were reported back in February. They indicated that both companies reported serious growth. That growth was reflected in their double-digit dividend growth.

The problem with the company lies in both banks’ connection to the Canadian consumer. Canadian consumers were cash strapped before this crisis hit. In fact, one of the reasons that Canadian consumers went to these financial institutions was because of their rather poor financial situations.

When borrowers were refused at the big banks, they would often go to these second-tier banks. This fact is especially true in the case of easyfinancial, which lends relatively small amounts at rates greater than 29.99%. If a serious economic recession takes hold, these borrowers could potentially default in great numbers, leaving easyfinancial in a situation.

The same holds true with Equitable, although Equitable appears to be the stronger of the two companies. Its loan book is of a more traditional nature, focusing on mortgages offered at a similar rate to the Big Five Canadian banks. Its issue lies more in its singular focus on the Canadian housing market. It simply does not have the scale that the larger banks possess.

The bottom line

While it appears that both of these banks possess excellent growth rates, I would not yet step into either of these names. Certainly, their prices have come down significantly over the past month. Nevertheless, they are very tied to a Canadian economy that is sitting on a razor’s edge at the moment. 

On the other side of this multifaceted crisis, it might be a good idea to buy shares of these companies. The time to do this is when the economy improves. There is no way to know how devastating the combined impacts of the coronavirus, government spending, and work shutdowns will be on the already weak Canadian economy. Proceed with caution.

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.

More on Dividend Stocks

worry concern
Dividend Stocks

Worried About a Recession? 2 Canadian Blue-Chip Stocks to Buy and Hold for Dear Life

A recession is worrisome. Buying two blue-chip TSX stocks and holding them for the long term will deliver stable, less…

Read more »

money cash dividends
Dividend Stocks

TFSA: 3 of the Best Canadian Dividend Stocks to Buy This Year

Are you looking for some of the best Canadian Dividend stocks to buy this year? Here are three great options…

Read more »

Man data analyze
Dividend Stocks

2 Recession-Tough Stocks to Buy in February 2023

TSX stocks, such as Jamieson Wellness, are trading at compelling valuations and might deliver stellar gains to investors.

Read more »

A worker overlooks an oil refinery plant.
Dividend Stocks

Defensive Investors: 3 Stocks to Shore Up Your Portfolio

Fortis is a defensive stock with an impressive track record.

Read more »

edit Woman calculating figures next to a laptop
Dividend Stocks

Passive Income: 2 Cheap Stocks to Buy and Never Sell

Buying dividend stocks cheap and discounted is a strategy many value investors pursue to maximize the return potential.

Read more »

Female friends enjoying their dessert together at a mall
Dividend Stocks

Dividend Stocks: Will Debt Load Put a Damper on This Top Stock in 2023?

This dividend stock has a very solid track record of revenue and cash flow growth, ,as well as dividend growth,…

Read more »

A plant grows from coins.
Dividend Stocks

How to Invest in One of the Most Important Commodities in the World (It’s Not Gold)

Many things we take for granted may offer economic value and a powerful investment opportunity beyond commodities like gold or…

Read more »

growing plant shoots on stacked coins
Dividend Stocks

Need Passive Income? Turn $15,000 Into $1,016 Annually With These 2 Dividend Stocks

Canadian investors with limited capital can create passive-income streams from two high-yield dividend stocks.

Read more »