Screening Canadian Bank Stocks? Here’s Your Best Bet for 2023

Canadian bank stocks might underperform in the near term. But they look well placed for the long term.

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If the broader economy tumbles next year, bank stocks will be the first to catch a cold. And we got a little preview of the same this year, with bank names tanking 12-15% from their record highs. But not all of the Big Six Canadian banks are equally exposed to macro challenges.

Canadian bank stocks and macro challenges

For the fiscal fourth quarter (Q4) of 2022, Canadian banks saw earnings growth slowing for some and higher provisioning for many. The provisions will likely trend higher for the next few quarters, given the impending rate hikes and roaring inflation.

Nearly all Big Six Canadian banks are fundamentally strong and have created a decent shareholder value over the long term. Currently, the average dividend yield investors can get around is 4.5%, which is fairly good in the current uncertain market.

I like Toronto-Dominion Bank (TSX:TD) better. It’s not that its dividends are superior and it’s cheap valuation-wise. However, its healthy credit profile and significant presence in the U.S. differentiate it from its peers. It’s retail banking south of the border could really be the growth driver in the long term.

How did Toronto-Dominion Bank fare in fiscal Q4 2022?

For the recently reported quarter, TD reported a net income of $17.4 billion, a decent 22% growth year over year. Average deposit volumes grew by 4% during the quarter compared to the fiscal Q4 2021. Its common equity tier-one (CET1) ratio was around 16.2% at the end of October 31, 2022. That’s much higher than the regulatory requirements and even peers’ average. Peer Royal Bank has it around 12% and Bank of Montreal at 16.7%.

It’s not like TD has stood strong on all the above parametres in the recent quarter compared to peers. However, the numbers indeed represent its business strength in the challenging environment.

In the last 10 years, TD has managed to grow its earnings by 9% compounded annually. Its return on equity averaged around 15% in the last 10 years. This stable earnings growth was well reflected in its stock, returning 13% compounded annually in the same period. In comparison, the Big Six, on average, returned 11.5%.

After a decent quarterly performance, TD increased its dividend by 8%, taking its yield to 4.2%. It aims to grow its normalized earnings by 7-10% next year. This looks achievable as its U.S. arm is growing much faster than its Canadian operations. Plus, we might see some respite on the provisions front, probably in the second half of 2023, uplifting banks’ bottom line.

TD stock is trading 17% lower from its 52-week highs early this year. It looks well placed for the long term with its scale and earnings stability. It is currently trading at a price-to-book value ratio of 1.6, which is marginally higher than peers. However, TD’s premium valuation looks justified and suggests investors’ above-average expectations from it.

Conclusion

As target inflation is still a distant dream for central banks, we might see more interest rate hikes next year. This might weigh on Canadian bank stocks, and a meaningful recovery could be delayed. TD stock looks attractive for the long term, given its financial strength, stable dividends, and strong execution.   

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.

The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. Fool contributor Vineet Kulkarni has no position in any of the stocks mentioned.

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