A sluggish macro environment in 2023 has driven the share prices of companies across multiple sectors lower. Investors remain wary of rising interest rates, leading to a tepid lending environment. Several central banks hiked bond rates to offset inflation, and these quantitative tightening policies have meant consumer spending has declined in recent months.
As the cost of debt rises, individuals and households will see a rise in mortgage payments, while businesses have to account for higher interest payments. So, as consumer spending slows in the near term, corporate profits also take a massive hit, which accelerates the selloff in the equity market.
Moreover, banking companies have to account for a rise in delinquency rates, narrowing their profit margins and earnings profile. These headwinds have dragged shares of Bank of Nova Scotia (TSX:BNS) lower by 38% from all-time highs. However, the selloff has increased its dividend yield to 7.2%, making BNS stock attractive to income-seeking investors.
Let’s see if you should buy BNS stock for its high dividend yield right now.
Is BNS stock undervalued or a value trap?
The Canadian banks are heavily regulated, which results in a conservative lending environment. It has also enabled banking giants, including BNS, to benefit from entrenched positions due to lower competition and high barriers to entry.
While several TSX banks have tried to expand their presence south of the border, BNS is focused on gaining traction in higher-growth markets in South America.
Scotiabank first paid its investors a dividend in 1833 and has maintained these payouts for almost 200 years, showcasing the resiliency of its cash flows. While several U.S. banks were forced to suspend or reduce their dividend payout during the Great Recession in 2009, BNS and its TSX peers could easily maintain dividends throughout the economic crisis. In the last 25 years, BNS stock has raised dividend by 9.9% annually, which is impressive for a cyclical bank stock.
Priced at 8.3 times forward earnings, BNS stock trades at a 15% discount to consensus price target estimates.
How did BNS stock perform in fiscal Q3 of 2023?
In the fiscal third quarter (Q3) (ended in July), BNS reported a net income of $2.22 billion and adjusted earnings of $1.73 per share. In the year-ago period, its earnings stood at $2.10 per share. The bank’s adjusted return on equity also fell to 12.2% from 15.4% in the year-ago period.
Despite an uncertain macro environment, BNS delivered another quarter of stable earnings and strengthened its balance sheet and liquidity metrics while increasing loan-loss allowances and managing expense growth prudently.
BNS ended Q3 with a common equity tier-one capital ratio of 12.7%, up from 11.4% in the prior-year quarter. Its liquidity coverage ratio also surged from 122% to 133% in this period. The two ratios are used to calculate a bank’s ability to withstand major economic downturns, and a higher ratio is favourable.
BNS increased its provision for credit losses by $407 million to $819 million in Q3, rising by 42 basis points. Its PCLs on performing loans more than tripled to $81 million, driving the net income lower in the process.
BNS has showcased its ability to perform well across market cycles and has a sustainable payout ratio. Its high dividend yield makes it a compelling investment option for income investors in 2023.
