Higher 'DSB' means smaller dividend increases for banks: Analyst
The big Canadian banks - darlings of retirement portfolios for delivering generous and consistent dividends - are losing their income-generating luster to once lowly guaranteed investment certificates (GICs).
Veritas Investment Research analyst Nigel D’Souza told BNN Bloomberg a move Tuesday by the federal banking regulator (the Office of the Superintendent of Financial Institutions or OSFI) to force banks to raise their cash requirements could crimp dividend payouts to shareholders.
Most Canadians who invest for retirement hold big Canadian bank stocks directly, in mutual or exchange traded Canadian equity funds, or in company pension plans. Even the Canada Pension Plan (CPP) owns stock in big Canadian banks.
The big banks; Toronto Dominion Bank, Bank of Nova Scotia, Bank of Montreal, Royal Bank of Canada, Canadian Imperial Bank of Commerce and National Bank of Canada have never missed or even lowered dividend payouts since Confederation.
Annual yields currently range from 4.2 per cent from National Bank, to 6.4 per cent from Bank of Nova Scotia.
In comparison, some one-year GICs are paying out over five per cent. Yields from big bank issued GICs are still under five per cent, but in some cases they are higher than the dividend yields on their stocks right now.
It’s important to know that GICs and bank shares are very different investment vehicles; as different as stocks and bonds. But when you’re retired - or near retirement - and need a steady and reliable income stream, income is income.
While individual dividend payouts might seem like a trickle, income from several income-generating investments adds up over time as it compounds. That makes both bank stocks and GICs ideal for a retirement portfolio.
Here are basic differences to consider when deciding how much of each you would want in your retirement portfolio.
GICS: STEADY CASH, NO RISK
As the name implies, the principal and yields on guaranteed investment certificates are guaranteed. Private borrowers issue them but the federal government ultimately backs them up. If Ottawa defaults, we’re all in big trouble.
The unprecedented rise in interest rates over the past 15 months has pushed GIC yields from near zero at the start of 2022.
They are expected to hold or rise as long as central banks like the Bank of Canada keep or increase their benchmark rates in their battle to cool inflation. If runaway inflation outpaces GIC yields, investors run the risk of having their returns gobbled up by a higher cost of living.
MORE RISK AND REWARD POTENTIAL FROM BANKS
Investors also run the risk of having bank dividend yields gobbled up by inflation but bank stocks are much riskier, and have much more reward potential than GICs.
Unlike GICs, dividend payouts on stocks are at the discretion of the company. Dividends are derived from profits. According to Veritas Investment Research, the new cash requirements placed on the banks will put those profits under pressure.
Historically, Canadian bank profits have grown over time regardless of short-term regulatory changes and even major events such as the 2008 global financial meltdown or the pandemic.
And so have their stock prices. The value of the TSX Composite Banks Index - which includes the big six banks - is 10 times higher than it was in 1996.
But that doesn’t mean they will continue to rise. The price of any stock at any given time reflects the confidence investors have in the company’s ability to grow profits, also called earnings.
Equity researchers like Veritas find investment opportunities through discrepancies between price and earnings that suggest a stock price could be trading below or above its true value relative to earnings.
A basic and common method is the price-to-earnings (P/E) ratio calculated by dividing the current share price by the earnings per share for the latest reporting period.
Historically, the P/E ratio for the big six banks runs in the mid to lower teens. Currently, they range from 9.6 to 12.3.
That suggests they might be a bargain, but all that changes as earnings change.