Valuations remain sky-high in most sectors. Accordingly, value seems to be confined to a few sectors right now. Financials (banks) are one sector that continues to look undervalued.
Fundamentals are everything these days
Why are banks so undervalued right now? I think a lot of this has to do with their solid fundamentals, relative to the amount of provisioning these banks have done for credit losses. When the pandemic hit, banks were forced to account for the forecast loan losses they would ensure. Given the amount of stimulus that’s been pumped into the market, it appears loan losses will not be as bad as initially thought. Additionally, I think Scotiabank has been conservative with its provisioning estimates.
Accordingly, Scotiabank could see tremendous bottom line improvement once these provisions are removed. If we exit this pandemic sooner than later, Scotiabank would be an immediate beneficiary. A rising tide would lift all boats. However, I think Scotiabank has fallen further than its peers, providing more potential upside.
Scotiabank’s 5.1% dividend yield is the best among its peers, in my view. I think this bank is poised to see capital appreciation on the horizon, lowering this yield. Scotiabank hasn’t traditionally traded at this sort of a discount to its peer group.
International growth the place to be
Fellow Fool contributor Joey Frenette likes the international growth exposure Scotiabank provides. Accordingly, in a recent piece he wrote: “Scotiabank has brilliant managers and is an easy (and probably safer) way for Canadians to gain exposure to the “growthier” international banking scene. Scotiabank stock suffered a massive 35% peak-to-trough drop in February and March, bringing shares down over 41% from their 2017 highs.
Today, the stock has since recovered a considerable amount of ground (BNS shares are up over 40% since March), but I still view deep value in the name as the world begins to heal from the pandemic in the latter part of 2021.”
I fully agree with this assessment. Canada’s largest banks with significant international exposure will benefit from a global recovery. We’re still in the early stages of this recovery now. Vaccines are being rolled out, slower than expected. However, when we do finally have visibility to the “end” of this pandemic, I think financials will start to take off. Additionally, those with high levels of international exposure like Scotiabank may outperform their peers.
Additionally, emerging markets have underperformed developed markets for quite some time. I expect a reversion toward the longer-term mean at some point. Accordingly, tilting one’s portfolio toward diversified global players may be a good move. Scotiabank may underperform the broader market for a while, but I think this stock has the potential to provide market-beating long-term returns for investors.
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Fool contributor Chris MacDonald has no position in any of the stocks mentioned. The Motley Fool recommends BANK OF NOVA SCOTIA.