Why Bank of Nova Scotia is a Buy

By: Benj Gallander

Has Benj lost it? Has he become a traitor after over 45 years of investing? Please do not come to that conclusion as he carefully considers whether he should buy shares in Bank of Nova Scotia (BNS-T).

Gallander got to know the institution well while pursuing his MBA degree at Dalhousie University, not so long after graduating from the University of Western Ontario. His thesis, done with four other students in 1983, was written when Canadian banks were having nightmares, primarily because of loans to what were then called “third world countries.”

The banks, in their zeal, were lending money to poor nations in their attempts to achieve higher rates of return. When the borrowers had difficulty paying back the loans, huge writedowns resulted. Fat bottom lines morphed into steep losses for the banks as the risk had not been adequately calibrated. Ultimately, of course, they pulled through, but not without considerable pain.

Currently bank share prices are taking another beatdown, with all of Canada’s majors losing a piece of their value. As a large percentage of Canadians are invested in this sector – either directly, through ETFs and mutual funds, or pensions – their net worth has been falling. Not attractive, to be sure. But for investors who do not need the money, the best thing to do, at least from this angle, is stay the course and be patient, as capital appreciation is likely and Canadian banks rarely reduce dividends.

However, here’s a suggestion: To dramatically reduce risks and solidify the Canadian economy, it is time the banks put the brakes on increasing dividends and, instead, pay down their obligations. This could be done by buying back preferred shares, of which each bank has many, and taking them out of circulation, thereby reducing the future dividends that need to be paid and ultimately fattening the banks’ bottom lines.

Will the federal government mandate something like this to help ensure the stability of the Canadian financial system? The odds are almost zero. Ottawa generally only acts after it is clear that a major problem exists. And as often happens, things often seem tickety-boo until they aren’t. Looking overseas, many people are asking why the Swiss government did not get involved with Credit Suisse before the bank was in such dire straits.

Given the recent slide in BNS’s share price to below $60, Benj is considering buying the common shares. Though the upside is far less than he normally targets when buying stocks – 100 per cent plus is the norm – an initial sell north of $80 seems reasonable. That would offer a handsome return from the current price, with dividends to boot.

We’re monitoring the valuation of BNS closely with the possibility that the stock is facing some tax-loss selling before the end of the year, which could drop its price further. In addition, the bank’s bottom line will be dinged by about $590-million, or 49 cents per share, owing to layoffs, consolidation of real estate and contract costs and a $280-million impairment charge owing to the investment in Bank of Xi’an. Less savvy investors might conclude that these one-off charges will continue to affect the bottom line.

They won’t, as they are one-offs. BNS is scheduled to announce its fiscal fourth-quarter and year-end results on Nov. 28.

A primary reason that this BNS share purchase is being deliberated is because of that old bugaboo, the stages of life. Yes, it is hard for Benj to believe and accept that he is now a senior, as he prefers to remember the teenaged lad trying out for four Major League Baseball teams.

Still, even with the passage of decades, he continues to practice his same old contrarian investment techniques, with minor modifications, but he’s also ratcheting up his eye on very secure corporations that pay handsome dividends, with an excellent possibility of capital appreciation. The transition will not be swift or dramatic but, as he loves to say when speaking in public, “Dividends allow me to be stupid longer.” If they are being received, at least there is some return on the outlay, while waiting for capital growth.

Benj has no time frame to achieve the $80-plus share price. He will simply sit back and clip the dividend coupons that are north of 7 per cent and enjoy their preferred tax status if he does indeed buy the shares. It might all seem quite boring, but dull can be good when investing.