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Bank on your bank stocks

Trading to profit from anticipated declines in stock prices seldom works. In the case of the bank stocks, forget it.

canadian_banks

Canadian banks: Buy low, if you can, and hang on.

The banks all reported strong results in the fiscal second quarter ended April 30. Core earnings for the six big banks were up more than 150 per cent to $14.4 billion. Much of the profit surge was caused by reducing the money kept in reserve to deal with loans that could have gone bad. The money set aside for this purpose is known as provision for credit losses, or PCLs.

But while the banks performed well in the second quarter, the American credit rating agency, Fitch Ratings Inc., more recently downgraded the operating environment for the Canadian banks to ‘AA-’ from ‘AA’. The downgrade reflects high levels of public and private debt, which the agency believes is negative for long-term business volumes and credit conditions.

Earnings will rise over long term

Despite the downgrade, the banks are still expected to do well over these next few years. Profit growth should continue to be strong in fiscal 2021, which ends October 31. And while growth may moderate next year, earnings are expected to continue to rise over the longer term, as they have over many years in the past.

A lot of the nearer-term growth, of course, is an accounting phenomenon. The banks set aside a lot of money last year, as an expense, to cover anticipated loan losses. As it turns out, loan losses were less than anticipated and the banks have reversed some of the expense and reclassified it as income.

But earnings growth should be driven less by lower PCLs as we move into future years and more by other factors. And while the operating environment for credit conditions may pose challenges, the banks have other avenues for growth as well, such as wealth management and capital markets.

Dividends will likely increase

So, while the Fitch downgrade raises some concern about aspects of the Canadian banks’ outlook, we don’t think its action justifies your selling your bank shares now. Remember, Canada’s six biggest banks all pay dividends that yield in excess of 3.0 per cent. And over time, the dividends they pay will likely increase.

Meanwhile, bank stocks also hold out the possibility of future capital gains. But some investors view the gains of the past year as an opportunity to sell and perhaps buy at a lower price sometime in the future. Problem with this strategy, of course, is you may never get the chance to buy back in at an advantageous price.

We characterize our investment philosophy as ‘buy and hold’. Better yet, buy low if you can and hang on. Canada’s banks have represented among the best investments available in this country over many decades. Why take a chance on losing out?

This is an edited version of an article that was originally published for subscribers in the August 13, 2021 issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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