Here are two big Canadian bank stocks that have underperformed the industry, and I have been buying on dips in their shares. Based on stock price alone, Toronto-Dominion Bank (TSX:TD) and Bank of Nova Scotia (TSX:BNS) stocks are down about 9% and 1%, respectively, over the last 12 months versus the BMO Equal Weight Banks Index ETF (TSX:ZEB).
TD, BNS, and ZEB 12-month stock price change data by YCharts
Dividends and cash distributions add to total returns. Since the big Canadian bank stocks pay out nice dividends, investors should account for them. Here are their total returns in the period, including dividends/cash distributions.
TD, BNS, and ZEB 12-month Total Return Level data by YCharts
Sit back and enjoy a big dividend
The ZEB yields about 4.5%. With Bank of Nova Scotia, investors can enjoy an outsized dividend yielding almost 6.7%, which is almost 48% higher than the income offered by ZEB. The dividend is covered by its earnings.
The bank’s international strategy has actually been a drag on its performance, though. Over the past decade, it increased its diluted earnings per share by only 1.2% per year. In the period, the bank did increase its dividend by about 75%, which equates to an annual increase of close to 5.8%. However, this means its payout ratio has been rising. This fiscal year, its payout ratio is estimated to be about 66% of earnings.
Normally, its payout ratio is about 50% of its adjusted earnings. Even based on estimated adjusted earnings, though, its payout ratio is expected to be roughly 65% this year.
The international bank stock’s valuation is very reasonable at about 9.8 times adjusted earnings at $63.67 per share at writing. Currently, Bank of Nova Scotia stock is a wait-and-see story to see if its more focused international strategy in Latin America will play out. Essentially, investors are getting paid a bigger dividend for the higher risk they’re taking in a stock that could turn around.
What about TD stock?
Toronto-Dominion Bank stock can provide a better mix of dividend income and price appreciation. Over the last 10 years, its total returns were almost on par with those of ZEB. Specifically, TD delivered returns of about 112% versus ZEB’s 126%. TD’s recent underperformance could be a good entry point.
TD is more focused on its retail banking operations in Canada and the United States. As well, it owns a meaningful stake in Charles Schwab. At $78.36 per share at writing, it trades at a price-to-earnings ratio of about 9.8 based on adjusted earnings, which is a discount of about 17% from its long-term normal valuation.
Compared to BNS, TD offers a smaller but still decently high dividend yield of 5.2%. TD’s dividend is covered by its earnings with a payout ratio of about 60% of diluted earnings and 51% of adjusted earnings this year. Analysts also agree that TD stock trades at a bigger discount than BNS stock.
Investor takeaway
Based on conservative estimates, investors could come away with solid returns of over 10% per year over the next five years in these bank stocks, while earning nice, passive, dividend income.
