Bank stocks sound like fabulous investments, don’t they? Everyone needs their money saved somewhere. It’s also convenient to borrow from the bank, though, of course, you’ve got to pay a fee in the form of interest.
Generally, the Big Six Canadian banks are in a good position, as they hold approximately 90% of the country’s banking deposits. Recently, though, a smaller bank saw a big jump in its stock. Specifically, Laurentian Bank of Canada (TSX: LB) witnessed a gap up, which essentially led to an appreciation of about 40% in the bank stock!
The stock move was triggered by the news in July that Laurentian was conducting a strategic review that could lead to a sale. Before the news, the stock traded at about $33 per share. After the news, the stock, at one point, hit as high as $48 a share. By then, the stock was already fully valued. So, it would have been smart of investors to avoid the stock then.
Surely enough, the market’s interest in the stock quickly evaporated. At writing, the stock has retreated to $39.76 per share. At this quotation, the stock is fairly valued, trading at about 8.2 times adjusted earnings. The consensus analyst price target also suggests the stock is fairly priced.
Though its dividend appears to be sustainable, there’s no margin of safety in the stock. Laurentian Bank’s current dividend yield of about 4.7% is also not particularly attractive. Investors may be better off choosing to own a large Canadian bank stock than Laurentian at this valuation. In the near term, Laurentian’s stock price could be quite volatile depending if a takeover takes place or not.
More importantly, investors should note that economists expect that a recession could arrive in Canada and the United States by 2024. If so, it would certainly be safer to own a big Canadian bank than a smaller one, although both are likely to experience turbulence (in their stock price and earnings) in a recession.
For example, Bank of Montreal (TSX: BMO) offers a bigger dividend yield of 4.9%. During the pandemic in 2020, unlike Laurentian Bank stock, which cut its dividend, BMO stock continued to raise its dividend. BMO’s 10-year dividend-growth rate of 6.8% is solid.
Investors shouldn’t have to worry about BMO stock’s dividend safety. Indeed, its payout ratio is estimated to be about 47% of adjusted earnings. Additionally, it also has a treasure chest of retained earnings that could serve as a buffer for the dividend if needed. That said, at least in the past 20 years, BMO has been profitable through economic cycles and earned sufficient earnings each year to cover its dividends with leftovers.
At about $119 per share at writing, Bank of Montreal stock trades at about 9.5 times adjusted earnings, which is a reasonable valuation. For your reference, the analyst consensus 12-month price target represents a discount of almost 10% in the stock. So, it would be smart of investors to consider buying Bank of Montreal stock over Laurentian stock, especially on a dip this month. Laurentian stock is more speculative, especially since the stock price is event driven in the short term.
