If you’re going to invest, it helps to think of stocks as businesses rather than random number generators. Sure, stock price swings can seem random. In fact, they are near-random in the short term. But over the long term, a stock’s total return (i.e., capital gains plus dividends) correlates very strongly with its success as a business. If a company is consistently profitable and growing, its stock is likely to perform well. With that in mind, here are two stocks that have very high yields and have quality businesses underlying them.
Bank of Nova Scotia
Bank of Nova Scotia (TSX:BNS) is one of Canada’s Big Six banks. Its stock currently has a 7.4% yield. This year, bank stocks have mostly fallen in price, as investors have been worried about about liquidity issues. Thanks to rising treasury yields, banks have seen the value of their investments decline. When banks’ investments decline in price, they have fewer liquid assets with which to pay off depositors should they “run.”
These days, many depositors are choosing to take money out of the bank and invest in treasuries, because they have higher yields than savings accounts. This results in banks having to sell treasuries to pay off depositors. Sometimes, they can’t sell enough securities to pay depositors off — this resulted in several U.S. regional banks failing this year.
The factors outlined above are major concerns for banks in general, but Canadian banks tend to be stable and well capitalized. In its most recent quarter, BNS had a 12.7% common equity tier-one ratio and a 133% liquidity coverage ratio, both well above what regulators require. In the quarter, the bank delivered 3.7% growth in revenue, while earnings declined slightly due to higher provisions for credit losses (PCLs).
An increase in PCLs is a non-cash charge that represents money banks set aside to cover non-performing loans. If the loans do not go into default, then the bank can reverse PCLs later, causing an abrupt spike in earnings. So, Scotiabank may fare well when the current economic malaise subsides.
First National Financial
First National Financial (TSX:FN) is another lender like Bank of Nova Scotia. Unlike BNS, First National is not a bank but a “non-bank lender,” meaning a company that loans out money without taking deposits. This is a desirable feature for a lender in 2023. This year, many depositors are fleeing to treasuries, as previously mentioned. That’s causing problems for banks, but it’s not a problem for non-bank lenders like FN. Such lenders don’t take deposits, they finance their loans with long-term bonds, so their need for immediate liquidity is lesser than that of a bank.
We can see the virtues of FN’s business model in its recent earnings. In its most recent quarter, FN delivered the following:
- $138 billion in mortgages under administration, up 8%
- $526 million in revenue, up 26%
- $89.2 million in net income, up 47%
- A mere 41% payout ratio
FN’s payout ratio means that it is only paying out 41% of its earnings as dividends. That’s a pretty low ratio, yet FN stock yields 6.9%. Overall, it’s a solid income play worth considering.
