The big Canadian banks are some of the most profitable businesses in our country. Their earnings tend to decline during recessions. Since we’re expected to experience a recession this year, the banks have been increasing their provision for credit losses (PCL) to prepare for a higher percentage and bigger amounts of bad loans. Higher PCL weighs on their earnings. When the economy improves, the banks release their PCL, which will boost earnings then. It’s all a part of the normal economic cycle.
Bank of Nova Scotia stock is the top bank for immediate income
With its greater international exposure, Bank of Nova Scotia (TSX:BNS) poses higher risk. Therefore, it has also been the highest-yielding big Canadian bank stock for sometime. And it remains the biggest dividend stock among its peers after reporting its fiscal second-quarter earnings and increasing its dividend.
Its income is valuable for investors who need immediate income. I’ll have you know that it’ll take the other banks at least 10 years to catch up to BNS stock’s income generation.
Here’s an elaboration. At writing, Bank of Nova Scotia offers a dividend yield of 6.35%. Assuming it continues to increase its dividend by 6% per year (which aligns with its 10-year dividend-growth rate of 6.4%), an investment today would reach a yield on cost of 10.73% in 10 years.
Toronto-Dominion Bank stock yields 4.94% at writing. Assuming it continues to increase its dividend by 9% per year (which aligns with its 10-year dividend-growth rate of 9.4%), an investment today would coincidentally reach a yield on cost of 10.73% in 10 years.
Using a similar dividend-growth projection for the other Big Six Canadian banks, they would reach yield on costs of 8.1-10.2% in a decade. So, Bank of Nova Scotia is the top Canadian bank stock for immediate income. Not surprisingly, as the second highest-yielding Canadian bank stock, Canadian Imperial Bank of Commerce comes close in second place for current income.
Recent results
Like most of its banking peers, Bank of Nova Scotia had higher PCL for the first half of the fiscal year. Specifically, the PCL jumped 205% to $1,347 million, dragging down reported net income by 28% to $3,931 million. As a result, diluted earnings per share fell 29% to $3.04. So, the payout ratio of about 68% was higher than the normal levels of around 50%.
Despite the macro headwind, the bank still raised its dividend by 2.9%. Notably, it has over $53 billion in retained earnings on its balance sheet that could help protect its dividend if needed.
Investor takeaway
At $66.72 per share at writing, Bank of Nova Scotia stock offers a juicy dividend yield of 6.35%. Furthermore, the dividend stock is undervalued, trading at a discount of about 25% from its long-term normal valuation. This means that assuming a sensible earnings-per-share growth rate of 5% per year and a reversion to the mean valuation over the next five years, investors could pocket very solid returns of over 16% per year in this period.
