Bank of Nova Scotia (TSX:BNS) is up about 14% in the past six months. Investors who missed the rebound are wondering if BNS stock is still undervalued and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) portfolio focused on high-yield dividend stocks.
Bank of Nova Scotia’s stock price
Bank of Nova Scotia trades near $65.50 at the time of writing. The stock slid to $55 last fall before bargain hunters started to move in on the hopes of interest rate cuts in 2024. In early 2022, the shares traded as high as $93, so there is decent upside potential.
The steep increase in interest rates in 2022 and through much of 2023 is largely responsible for the pullback in the share price. Investors worried that the Bank of Canada and the U.S. Federal Reserve would have to drive the economy into a recession to get inflation under control. So far, the economy has absorbed the rate hikes without much trouble. This has kept employment levels high, which is helping households manage elevated debt expenses.
Economists broadly expected the Bank of Canada to start cutting rates in the next few months. This should ease pressure on businesses and households that are carrying too much debt and reduce the potential for a wave of loan defaults. Expectations for 2024 rate cuts and a soft landing for the economy are the reason bank stocks picked up a tailwind through the end of last year.
Earnings
Bank of Nova Scotia just reported solid fiscal second-quarter (Q2) 2024 earnings. Net income in the quarter slipped slightly to $2.09 billion from $2.15 billion in the same period last year, but net income is up for the first six months of fiscal 2024, coming in at $4.3 billion compared to $3.9 billion in the first half of fiscal 2023.
Return on equity dipped to 11.3% in the quarter from 12.3% in Q2 2023 but remains at a healthy level.
Higher interest rates help banks generate better net interest margins. However, the steep rise in rates over such a short period of time is driving higher loan losses as more borrowers struggle to make the increased payments. Bank of Nova Scotia reported a provision for credit losses (PCL) of $1 billion in fiscal Q2 2024 compared to $709 million in Q2 last year. For the first half of fiscal 2024, PCL is $1.97 billion compared to $1.35 billion in 2023. The trend of elevated PCL is expected to continue until the central banks start cutting interest rates, but the overall loan book remains in good shape.
Bank of Nova Scotia has ample capital to ride out ongoing turbulence. The company finished fiscal Q2 2024 with a common equity tier-one (CET1) capital ratio of 13.2%, up from 12.3% in the same quarter last year. Canadian banks are currently required to have a CET1 ratio of at least 11.5%, so there is a good buffer in place.
Dividends
Bank of Nova Scotia raised the dividend in 2023, and another increase should be on the way this year. Investors who buy BNS stock at the current level can get a 6.5% dividend yield. This is a lucrative return considering the stability of the distribution and the profitability of the bank.
Risks
Sticky inflation could force the central banks to keep interest rates elevated for an extended period of time. Inflation for April 2024 came in at 3.4% in the United States and 2.7% in Canada. This is still above the 2% target. The Bank of Canada will likely cut rates first, but it can’t diverge too much from the U.S. Federal Reserve. It is possible that rate cuts in the United States might not begin until 2025. If the central banks are forced to keep rates high well into next year and the economy slides into a recession, there could be more pain for bank investors, and a pullback to the 2023 lows wouldn’t be a surprise.
Economists still expect a soft landing for the economy, but it isn’t guaranteed.
Should you buy Bank of Nova Scotia stock now?
Ongoing volatility should be expected until the central banks begin to cut rates. That being said, BNS stock is likely still oversold considering the solid ongoing financial performance. Investors who buy now get paid well to wait for the next move to the upside. Market sentiment can change quickly, as we saw last fall, so there is a chance that the stock could also move meaningfully higher before the end of the year.
If you have some cash to put to work, this stock should deliver decent returns over the long haul and deserves to be on your radar for a portfolio focused on high dividend yields.
