Investing

Hot Stock: National Bank

An open secret in banking.

 

(Photo: John Zada)

(Photo: John Zada)

On May 24, National Bank of Canada (TSX: NA) put a smile on its investors’ faces by announcing  a dividend increase and share buy-back. It also revealed that its second quarter profit hit a record $369 million, significantly beating analyst estimates.

News like that gets Barry Schwartz excited. The vice-president of Baskin Financial says that while he owns a few banks, his largest financial sector position is in National, Canada’s sixth biggest bank. National, he points out, has the highest return on equity of any bank—20% compared to about 15% for the others—and has grown its dividend six times since mid-2010. “It seems to be able to do it all,” he says.

But what’s most interesting about this bank is not that it’s doing well—most of the banks are humming along just fine—it’s that it’s trading at about a 15% discount to other banks. Its price-to-earnings ratio is 9 times, while other institutions are trading between 10 and 12 times earnings.

Schwartz can’t understand why it’s not trading in line with its peers. “I don’t know why it’s still so inexpensive compared to the rest of the banks,” he says. “Yet it’s reporting some of the best quarterly earnings of the banks.”

He does have some theories as to why it’s so cheap—its market share is more heavily concentrated in Quebec; it’s more of a domestic operation than Scotia or TD, which have branched out beyond Canada’s borders; it has more housing exposure than other institutions and it once had a pretty big run in with regulators over its asset backed commercial paper holdings.

None of that, though, is cause for concern, says Schwartz. “Investors are suffering from some kind of post-traumatic stress disorder and applying what happened in the past to the future,” he says. “There are no issues and it will continue to report record earnings.”

So while he’s bullish on National in large part because it’s cheap, he also thinks the Canadian financial sector as a whole is undervalued and that multiples will rise. Institutions have more than enough capital to cover for any setbacks, he says, and most are now raising dividends again. National has said it wants to grow through acquisition—Schwartz thinks it could beef up its profitable wealth management business—and he doesn’t see why it can’t trade at 12 to 13 times earnings.

The stock is down about 0.3% year-to-date, but Schwartz expects it to eventually hit $100. A number of analysts who cover the company think its stock price will rise too; most 12-month price targets range from $80 to $88. With a 4.52% yield and capital gains potential, it’s this company, he says, that has the best return potential of all the banks. It won’t be long before investors figure that out. “The dividend will go up again in 2014. It’s buying back its own stock and earnings are improving,” he explains. “People are now starting to talk about it.

For more investing insights, follow Bryan on Twitter @bborzyko