Canadian banks are currently cheap by historical standards. As a group, they trade below 10 times earnings, despite having among the best earnings growth of any TSX sector this year. Most Canadian banks had positive earnings growth in the first half. In the second quarter, the growth turned negative due to increased risk factors, but the first quarter was strong enough to make the overall first half strong.
In contrast, TSX tech and energy stocks mostly saw their earnings decline in the first half.
In this article, I will explore one TSX bank stock that is way too undervalued today.
Bank of Nova Scotia
Bank of Nova Scotia (TSX:BNS), otherwise known as “Scotiabank,” is a Canadian bank with operations all over the world. It started off as a Canada-only bank then later expanded to Latin America, Asia, and other markets.
Over the last five years, Scotiabank’s growth hasn’t been as good as that of other Canadian banks. The company’s revenue has only grown by 2.34% annualized over the last five years. Its earnings have declined slightly in the same period. Its focus on emerging markets gives it ample diversification, but many of the markets BNS operates in are less stable than Canada and the United States. So, the more North American Canadian banks have performed better.
Recent earnings
Bank of Nova Scotia delivered a lukewarm performance in its most recent quarter. In it, the company delivered the following:
- $2.16 billion in net income, down 21%
- $1.69 in diluted earnings per share (EPS), down 21%
- A 12.3% return on equity, down from 16.2%
Overall, it was not a great showing, and the company missed expectations. However, the company’s long-term trajectory has been significantly better, as you’ll see shortly.
Long-term trajectory
Scotiabank’s long-term growth trajectory has been satisfactory. It hasn’t been great compared to TD and Royal Bank, but it has been pretty good. Some highlight metrics (annualized over five years) include the following:
- Revenue: 2.34%
- Gross loans: 8%
- Net income: 0.03%
- EPS: -0.33%
- Book value: 5.74%
- Common equity: 6.06%
As you can see, earnings have declined very slightly, but book value is up quite a bit. So, the bank is still growing its asset base, which empowers it to write more loans in the future.
A 6.5% dividend yield
You might wonder why I am calling Scotiabank stock undervalued when I just said it has no earnings growth. Shouldn’t a company that’s not growing have a low price-to-earnings ratio?
Yes, it should. However, Scotiabank is currently so cheap that it is arguably worth it.
Scotiabank is expected to pay $4.24 in dividends in the next 12 months. If you discount $4.24 at a 5% discount rate (the interest rate plus a risk premium), you get a $85 fair value estimate. However, Scotiabank only costs $65 today. So, the stock is arguably worth buying based on dividend income alone. It would take only 15.4 years to earn back your investment in the stock with dividends, and the stock’s fair value is greater than its current price using a dividend discount model. So, BNS stock may be worth it.
