Stock Analysis - Bank of Nova Scotia

What is one of the things that Canada is known for?  When it comes to banks, the big 5 banks in Canada are known as some of the best banks in the world.  The big 5 banks are known as Royal Bank of Canada (RY), Canadian Imperial Bank of Commerce (CM), Bank of Montreal (BMO), Toronto-Dominion Bank (TD) and the Bank of Nova Scotia (BNS).  Canadian Bank of Commerce is more commonly known as CIBC.

All 5 of these banks trade on the New York Stock Exchange and Toronto Stock Exchange.

I previously did an analysis on RY and TD.  These 2 banks I have owned in the pass, but do not currently own them.

Nowadays, an individual needs more than one source of income.  The job wages have been stagnant for the most part since the 70s, but adjusted for inflation.  In fact, the generation right behind the baby boomer's generation is believed to have it worse off than their parents.  This is the first time in history that this will occur.  In the early 1990s, the federal government of Canada has increased the amount of student loans that a student could possibly borrow by over $5000.  The government wanted anybody the opportunity to attend University.  The downsides to this is students have crippling student loan debt and the market is saturated with university educated people.

One of the sources of income could come via investing in the stock market.  See, when an investor buys shares of stock in a company, they become part owner of that specific company.  Being a part owner of a company means you can receive a share of the profits via a dividend.  Each company has a board of directors that determine if a dividend is paid or not paid.  The board of directors also determine the amount of dividend and the payment day of the dividend.  As the company grows over time and becomes more profitable, the dividend could be raised.  Collecting dividends is a great source of passive income and requires very little work on your part.

Bank of Nova Scotia (BNS)

Bank of Nova Scotia trades on both the New York Stock Exchange and Toronto Stock Exchange under the ticker symbol BNS.  BNS has paid dividends since 1833.  It has increased the dividend 42 of the last 45 years.  The dividend was not raised or cut in 2009 or 2010.  This was due to the fact that the world just went through the biggest recession since the Great Depression.

The Bank of Nova Scotia provides various financial services in North America, Latin America, the Caribbean and Central America, and the Asia-Pacific. It offers financial advice and solutions, and day-to-day banking products, including debit and credit cards, chequing and saving accounts, investments, mortgages, loans, and related creditor insurance to individuals and small businesses; and commercial banking solutions comprising lending, deposit, cash management, and trade finance solutions to medium and large businesses, including automotive dealers and their customers. The company also provides a suite of investment and wealth management advice, services, products, and solutions to customers, as well as advisors. Its asset management business focuses on developing investment solutions for retail and institutional investors; and wealth management solutions include private customer, online brokerage, full-service brokerage, pension, and institutional customer services. In addition, the company offers corporate lending; trade finance and cash management; investment banking services comprising corporate finance, and mergers and acquisitions; fixed income and equity underwriting, sales, trading, and research services; prime brokerage and stock lending services; foreign exchange sales and trading services; commodity derivatives; precious and base metals sales, trading, financing, and physical services; and collateral management services for corporate, government, and institutional investor clients, as well as international banking services for retail, corporate, and commercial customers. Further, it provides mobile, Internet, and telephone banking services. The company operates a network of 963 branches and approximately 3,600 automated banking machines in Canada; and approximately 1,800 branches internationally, as well as contact and business support centers. The Bank of Nova Scotia was founded in 1832 and is headquartered in Toronto, Canada  (source:  Yahoo Finance)

This analysis is going to be done using the stock on the Toronto Stock Exchange.  Bank of Nova Scotia was trading $77.00 per share as of June 22, 2018 at the close of the trading day.  The current annual dividend is $3.28 per share.  Therefore, the current yield is  4.26%.  This yield is higher than of the broader market (S&P TSX Composite Index) of 3.0% and greater than the stock's own 5 year average of 4.0%.

Bank of Nova Scotia  has paid a dividend since 1833.  That is longer than Canada has been a country!! The dividend have been raised 8 consecutives years.  The dividend was not raised or cut in 2009 and 2010, which was coming during and shortly after the great recession.

The 5-year and 10-year dividend growth rate 6.8% and 5.8%, respectively. The 10-year dividend growth rate includes the 2 years that BNS did not raise or lower the dividend.  The dividend growth beats the average rate of inflation.

The stock looks great so far.  But, we do not want to buy the stock just because the yield is good.  An analysis of the stock with some key fundamentals and then try to value the stock allows an investor to see if the stock is undervalued or overvalued.

Bank of Nova Scotia grew revenues from $11.876 billion in fiscal year 2008 to $27.155 billion in fiscal year 2017.  That is a CAGR of 9.62% over the last 10 years.  Morningstar has 2017 revenue of $ 26.748 billion as they did not include $407 million in net invested income from the bank's investment in other associated corporations.

The CAGR of 9.62% for Bank of Nova Scotia's over the last 10 years is impressive.  With interest rates were kept low ever since the great recession of 2008.  The interest rates by the Federal Reserve and Bank of Canada only started to be raised in the past year.  With so low interest rates, this is enticing to people to borrow money.  When people borrow money, it means more revenues to the bank from the interest collected on loans, mortgages, credit cards and lines of credit.

Bank of Nova Scotia grew earnings per share (EPS) from $3.05 in fiscal year 2008 to $6.49 in fiscal year 2017. That is a CAGR of 8.75% over the last 10 years.

The EPS CAGR of 8.75% is even more impressive as Bank of Nova Scotia was affected the great recession in 2008-2009. With growing earnings, some of those increased earnings are passed on to investors with increasing dividends.

The long-term debt to equity ratio comes in  0.10.  The interest coverage ratio comes in 2.16.

I would of liked to see an higher coverage ratio.

Is the Bank of Nova Scotia profitable?  Let's take a look at couple of fundamentals.

The average Return on Equity over the last 5 years comes in at 15.1%.  The average net margin over the 5 years comes in at 29.1%.

At net margin of 29.1% is great.  Net margin tells me the after everything is accounted for this is the amount of each dollar that is net profit.

Valuation

As of June 22, BNS is trading at P/E ratio that is slightly lower than the stock's own five year overage of 11.9. The current P/E ratio of 11.2 is lower than in industry average and is greatly lower that the broader market, which is the S&P TSX Composite Index
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The stock is currently trading at a price to cash flow (P/CF) of 3.7. This is drastically lower the the stock's own 3 year average of 487.  The current P/CF of 3.7, is lower than the industry's 3-year average of 6.4 and that of the broader market of 9.2.

We do not want to pay any price of a stock.  We now must do valuation exercise to determine a fair value of the stock.  Valuing a stock is not an exact science.  As investors, we want to buy stock much lower than the fair value of a stock which gives us a larger margin of safety.

A dividend discount model will be used.  The dividend discount model analysis is a procedure for valuing a stock's price by discount predicted dividends back to the present day. If the fair value price determined from the dividend discount analysis is higher than the stock's current price, than the stock is considered under valued.

A dividend growth rate of  5% annually for the first 5 years and then at 7% for the following 5 years. and a discount rate of 10%.

The dividend discount analysis gives us a fair value of $107.00.

We looked to look at a independent 3rd party research for fair value to judge if we valued the stock correctly. Ideally, we would like to use more than one 3rd party.

Morningstar rates BNS.TO as a 3-star stock and gives it a fair value of $80.00.

The average of these 2 values gives us a fair value of $93.50

Currently the stock is trading at $77.00 per share.  This indicates that Bank of Nova Scotia shares are possibly 21% undervalued.

A chart that shows the YTD for BNS.TO

Click to Enlarge

Summary:

The Bank of Nova Scotia is one of the best banks in the entire world.  The great part of it is that we can become a part owner of this bank.  As the world's population increases, so will the need for banking services.  The stock is down over 5% year to date.  As the chart shows, there seems to be a line of support around the $76 dollar mark for the calendar year 2018.   The stock could be possibly 21% undervalued.

BNS has been raising its dividend after every second quarter for the past several years. The current yield is very attractive as stock prices have been generally considered overvalued in this bull market.

Disclosure:  Long BNS.TO

DISCLAIMER

I am not a financial planner, financial advisor, accountant or tax attorney. The information on this blog represents my own thoughts and opinions and should NOT be taken as investment or business advice.

Every individual should do their due diligence to make their own financial decisions based on their financial situation and tolerance for risk