The big Canadian bank stocks are excellent passive-income investments. It doesn’t take long for investors to look up the dividend yields of Royal Bank of Canada (TSX:RY) and Bank of Nova Scotia (TSX:BNS) and find that the latter bank stock’s dividend yield is much higher. How much is the difference? RBC’s dividend yield is 4.08% at writing, while BNS stock’s dividend yield is 6.25%. So, BNS stock pays approximately 53% higher dividend income than RBC stock.
Is Bank of Nova Scotia stock a better dividend buy?
If current income is your top priority, then BNS stock is absolutely a better dividend buy. Let’s take a look at their dividend-growth history to compare their future dividend income potential. RBC stock’s 10-year dividend-growth rate is 8.1%, while BNS stock’s is 6.4%.
Let’s assume they’re able to grow their dividends by 8% and 6% per year, respectively, going forward. In 10 years, RBC’s yield on cost would be about 8.2%, while BNS’s would be close to 10.6%. It’ll take 24 years(!) before the same investment in RBC stock today will catch up to BNS stock’s yield on cost of close to 24%.
What if you care more about total returns?
If your focus is more on total returns, then Royal Bank of Canada stock has been a much better buy-and-hold dividend stock. For example, in the last 10 years, RBC stock returned about 10.5% per year — slightly more than double BNS stock’s return of roughly 5.4% annually in the period.
This has partly to do with how well Royal Bank stock has held up during this banking sector downturn versus Scotiabank. The graph below illustrates the banks’ stock price action over the last 12 months. It’s obvious that RBC stock has been much more resilient thanks to its leadership position, well-managed business, and diversified operations across personal and commercial banking, wealth management, capital markets, insurance, and investor and treasury services. RBC is also geographically focused on Canada and the United States, generating roughly 84% of its revenues in these countries.
RY and BNS data by YCharts
Valuation matters
One thing that could make Bank of Nova Scotia stock a better buy today is its valuation. While RBC stock trades at a premium valuation of 11.3 times earnings, BNS stock trades at a low price-to-earnings ratio (P/E) of about 8.2. To provide a clearer picture, RBC stock has a long-term normal P/E of about 12.1, while BNS’s is about 11.5 times.
So, BNS stock has a much bigger upside potential from valuation expansion. What’s weighing on the stock? Its international strategy has been more of a drag on its business results over the last few years. Particularly, the bank saw a meaningful decline of 21% in its diluted earnings per share (EPS) during the 2020 pandemic year versus RBC’s diluted EPS decline of 11%. This suggests that although BNS’s international strategy could theoretically lead to higher long-term growth, the underlying operations are also riskier in nature.
In recent years, Scotiabank has expanded its wealth management business with acquisitions, making it the third-largest active manager in Canada. Simultaneously, it has also exited some international operations while being more focused in other areas, such as targeting Chile and Colombia. Moreover, it’s a wait-and-see story, as investors hope the new chief executive officer Scott Thomson will right the ship over the next few years. If things work out, investors would get greater returns in higher-risk BNS stock over RBC stock over the next five years.
