Canadian Banks: Safe Place to Park Cash

Canadian banks operate within a government-protected oligopoly. While they are tightly regulated by the federal government, they are widely considered to be among the safest in the world and a source of reliable dividends and capital gains.

They can be roughly divided into the "Big 6" and the "challenger banks." The Big 6, as the name implies, are the biggest banks in the country, with the smallest of them, "National Bank of Canada (TSX:NA, Financial)," having a market cap of $25.6 billion. The challenger banks are the smaller players which are either regional or have an online presence. See the Appendix at the bottom for my list of the most notable Canadian banks.

Royal Bank (TSX:RY, Financial) and Toronto-Dominion (TSX:TD, Financial) are the top two Canadian banks. Royal dominates in Canada, while Toronto-Dominion has a large presence in the U.S. The Bank of Montreal (TSX:BMO, Financial) also has a significant U.S. presence.

Bank of Nova Scotia (TSX:BNS, Financial) has a stronger presence in South America where the economy has been slow to recover from the pandemic. Therefore, I think this bank can play "catch-up" with the rest of the cohort. It has recently released strong numbers, so the near term outlook looks good.

The following bubble chart plots the major Canadian banks, with the size of the bubble representing market cap, the Y-axis showing five-year book value growth and the X-axis showing the price-earnings ratio. Among the larger banks, Canadian Imperial Bank of Commerce (TSX:CM, Financial) seems to be in a sweet spot with a book value CAGR of just over 9% and a price-earnings ratio of 10. Among the smaller banks, Equitable Group (TSX:EQB, Financial) has a very high book value growth rate of around 15% and a price-earnings ratio of less than 9.

Home Capital Group (TSX:HCG, Financial) is another "challenger bank" to the "Big 6" and is balancing faster growth with a low earnings multiple. It currently does not pay a dividend, which is rare among Canadian banks, but it has impressive stock buybacks. It bought back 9% of outstanding shares in the last year. It is my favorite bank in the challenger sub-group.

It should be noted that the Big 6 banks were until recently prevented from raising dividends or buying back stock by the Canadian banking regulator, during the pandemic. These restrictions have now been lifted and the banks are raising dividends significantly and are also expected to start stock buybacks.

Conclusion

Canadian Banks, like their U.S.cousins, have come out of the pandemic stronger than ever. This is because of the massive fiscal and monetary stimulus pushed through by governments during the pandemic. Banks were the primary channel through which this tsunami of money reached the public. Now with interest rates rising, the banks are set to benefit once again as interest rate spreads between deposits and loans rise. They are making out like bandits coming and going. I am happy to be shareholder of this oligopoly, though I am unsure of whether these effects will be positive in the long-term for me as a citizen.

The Big 6 all boast solid returns on equity, moderate price-book and price-earnings ratios and decent book value growth. All pay good dividends. An effective way to own them is through an ETF for those who don't want to do the research on individual stocks. Some Canadian banking ETFs include the iShares S&P/TSX Capped Financials Index ETF (XFN), the iShares Equal Weight Banc & Lifeco ETF (CEW) and the iShares Canadian Financial Monthly Income ETF (FIE).

Among the challenger banks, I am partial to Home Capital Group and Canadian Western Bank (TSX:CWB, Financial) because of better valuation and growth prospects . Additionally, they can carry more risk than the Big 6, meaning that the upside potential is higher (though the downside potential is also higher).

Appendix