The share prices of Canada’s biggest banks have surged over the past year as global investors look to diversify and park their money outside of the United States amid economic uncertainty, a falling U.S. dollar and high valuations. However, some analysts are questioning whether that trend can help continue the rally.
Challenging Setup for Earnings Season
Mike Rizvanovic, an analyst at Bank of Nova Scotia, said in a note on Thursday that while he remains constructive on the large banks’ medium-term outlook, the setup heading into second-quarter earnings season is somewhat challenging. Various metrics suggest that the Canadian banks could potentially be overvalued.
Price-to-Earnings Ratio at Historical Highs
For example, the Big Six’s price-to-earnings (PE) ratio has surpassed historical highs. The PE ratio was about 13.7 on May 5, according to Rizvanovic, meaning investors were willing to pay $13.70 for every $1 of earnings the banks are expected to generate, comfortably above the historical average of 11.2. This indicates that investors are pricing in fairly high profit expectations, so the bank’s earnings being released next week may not give stocks much of a lift unless they clearly beat analysts’ forecasts.
Price-to-Book Value Also Above Average
The banks’ price-to-book value is also trading above historical highs: 2.2 compared to the 10-year historical average of 1.6, according to Paul Holden, an analyst at Canadian Imperial Bank of Commerce. He stated in a note on Wednesday that he expects a strong set of earnings, predominantly based on capital markets activity, but the credit outlook is incrementally worse. Given where valuation multiples sit, he questions whether the stocks will trade higher on capital markets-driven beats.
Dividend Yields Less Attractive
Holden also noted that the banks’ dividend yields are less attractive than in the past, with an average yield of three per cent compared to the 10-year average of 4.4 per cent.
Consistent Beats May Continue
However, the Big Six have consistently beaten expectations in the past two years, so it may be unwise to bet against them, according to Gabriel Dechaine, an analyst at National Bank of Canada. He said in a note on Thursday that barring a margin or credit surprise, the onus falls on the capital markets to deliver this outcome, which isn’t impossible considering several favourable market conditions.
Global Investors Seek Diversification
One of those favourable market conditions includes global investors looking for ways to diversify away from U.S. dollar assets and AI-heavy U.S. stock market dynamics amidst economic uncertainty, said Mehmet Beceren, a senior markets strategist at Rosenberg Research & Associates Inc. That search has led investors towards metals, oil, gold and markets that offer a more tangible link to resources, which Canada has plenty of.
