The Big Six Canadian banks collectively hold approximately 90% of the nation’s deposits. Because of their large deposit base, they benefit from relatively low funding costs. As Domestic Systemically Important Banks (D-SIBs), they are required to have a capital buffer of 3.50% of total risk-weighted assets by November 1, 2023, so that they can easily adjust to key vulnerabilities and system-wide risks according to the regulator, the Office of the Superintendent of Financial Institutions (OSFI).
The Canadian Bankers Association wrote in May 2023 that the “banks in Canada are recognized worldwide for their strength and resiliency, prudent lending practices, large and diverse deposit bases and diligent government oversight. More than 99% of working-age Canadians have an account at a financial institution, surpassing the 91% rate in the United States.”
They are some of the most profitable businesses in Canada. In the trailing 12 months, the Big Six Canadian banks collectively reported a whopping net income of $52.5 billion, with Royal Bank of Canada (TSX: RY) and Toronto-Dominion Bank (TSX: TD) being in the lead, with net income of north of $14.5 billion each.
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Interested in the big Canadian bank stocks?
Investors who want exposure to the Big Six Canadian banks (perhaps a more or less equal weight exposure) can look into BMO Equal Weight Banks Index ETF (TSX: ZEB). The exchange-traded fund (ETF) is weighted 16-17% in each of the big bank stocks. Its current distribution yield is approximately 5%, paid out as monthly cash distributions. Notably, the ETF has a management expense ratio of 0.28%, which cuts into your returns every year.
Still, in the last 10 years, the ZEB ETF delivered annualized returns of almost 9%, ahead of the Canadian stock market return of just north of 8%. ZEB’s cash-distribution yield is also higher than the Canadian stock market yield of close to 3.3%.
ZEB, RY, and TD Total Return Level data by YCharts
Want to buy the leading Canadian bank stocks?
Since peaking in 2022, the banks have pulled back and have been stuck in a sideways range. That said, both RBC and TD stocks have outperformed the ZEB in the last 10 years, delivering annualized returns of close to 10.4% and 10.2%, respectively.
RBC’s business may be relatively resilient, because it is primarily diversified across personal and commercial banking business and wealth management operations. At $120.19 per share at writing, Royal Bank of Canada stock offers a slight discount of 11.5%, according to the 12-month analyst consensus price target. At this quotation, it offers a dividend yield of approximately 4.5%.
Analysts believe retail banking-focused TD also trades at a similar discount of 10.7%. At $81.76 per share, TD stock provides a slightly higher dividend yield of 4.7%.
Because of the decent valuation, with solid earnings growth, over the next five years, RBC and TD stock could both potentially deliver annualized returns of about 12%.
Investor takeaway
In a long-term diversified stock portfolio, investors should hold a portion (perhaps about 10%) in the big Canadian bank stocks. By buying at good valuations, you can collect safe and growing dividend income over time without worries about the ups and downs of the economic cycle. Holding the banks is better than holding gold because the former group produces income.
