Bank of Nova Scotia (TSX: BNS) saw its share price rise 20% in the past 12 months, but the stock has underperformed its large TSX peers over the past five years.
Contrarian investors looking for good dividend yields and a shot at decent upside potential are wondering if BNS stock is now undervalued and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) portfolio.
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Bank of Nova Scotia stock price
Bank of Nova Scotia trades near $74 per share at the time of writing. It was as high as $93 about three years ago before the bank sector went into a pullback on worries that rising interest rates would trigger a recession in Canada and the United States.
Bank of Nova Scotia and the other banks all raised provisions for credit losses (PCL) in the past couple of years as higher interest rates put pressure on businesses and households that were carrying too much debt. Fortunately, the economy held up well and unemployment hasn’t increased in Canada as much as was feared, so the hit has been bearable. South of the border, the economy remains robust, as does the labour market.
Rate cuts that occurred in Canada and the United States in the second half of 2024 drove the sharp rally in bank stocks through the fourth quarter of the year as investors started to bet on better earnings from the banks as PCL declines. That could turn out to be the case, but it is not guaranteed.
Risks
If Donald Trump implements widespread tariffs on good coming from Canada there could be a double whammy for the Canadian banks. Higher costs for U.S. buyers would likely be passed on to American consumers. This would push up inflation, potentially forcing the U.S. Federal Reserve to increase rates again. That would put pressure on the Bank of Canada to hold rates steady, or at least slow down its pace of rate cuts, even if deeper cuts are needed to reduce interest rates to support the economy.
Tariffs put in place for an extended period of time would hit the Canadian economy, leading to a jump in unemployment just as hundreds of thousands of households are facing mortgage renewals at rates that are much higher than their current rates. In the worst case scenario, the banks could see a wave of loan defaults.
Opportunity
Bank of Nova Scotia has a strong capital position to help it ride out some turbulence. The bank is also working through a strategy shift that will see it invest more in the United States and Canada to drive growth. International operations in Latin America, where previous management targeted investments, are now being sold, or will receive less capital. Bank of Nova Scotia recently announced the sale of its businesses in Colombia, Panama, and Costa Rica. It also has a large presence in Mexico, Peru, and Chile.
It will take some time for transition to deliver results, but the strategy shift could bring more investor interest to the stock in the next couple of years.
Should you buy now?
Near-term volatility is possible, but contrarian investors who like the new strategy might want to start a position at this level and look to add on any additional weakness. At the current share price, BNS stock provides a dividend yield of 5.75%, so you get paid well to wait for a recovery.
