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For Investors With A Long Investment Horizon, It's Still A Good Time To Buy The Big Five Canadian Bank Stocks

Summary

Canada's banking system is a protected oligopoly, with predominantly five large banks serving the nation's entire population.

In contrast, the United States has a substantially greater competitive banking landscape, with over 6,000 banks and over 7,000 credit unions serving 330 million citizens.

The Big Five banks dominate Canadian banking, with 90% of the country's deposits. This dominance, and the regulatory protection they enjoy, make it unlikely new entrants will challenge their position.

Introduction

The Big Five Canadian banks have performed well as long-term investments, but periodically experience temporary declines, as they are now, in the aftermath of Brexit, but they should recover. They always have.

Source: The Toronto Star

It is difficult to find safe investments with 4%+ dividend yields and solid growth prospects. The benefits of investing in high-quality stocks with above-average yields, good growth prospects and trading at attractive prices are well-known to long-term investors. This article discusses such a group - the Big Five Canadian bank stocks.

In Canadian banking, these five banks stand above the rest in terms of assets, deposits and capitalization. On March 31, I published an article on Seeking Alpha entitled, A Good Time To Buy The Big Five Canadian Bank Stocks.

In that article, I stated that "Big Five" had become an outdated moniker, which no longer adequately describes these institutions' position in the Canadian domestic banking sector and, more broadly, the global banking sector. By this I meant that the assets held by the Big Five Canadian banks have ballooned in size over the past decade, crossing the threshold into gargantuan territory.

Royal Bank of Canada (NYSE:RY) and Toronto Dominion Bank (NYSE:TD) became Canada's first trillion-dollar banks, measured by total assets, and the Bank of Nova Scotia (NYSE:BNS) is not far behind. Only four banks in the U.S., an economy 10 times the size of Canada, have crossed into trillion-dollar territory, reinforcing how massive these five institutions are in relation to the substantially smaller Canadian economy.

At the time of writing that article in March, the Big Five bank stocks were recovering, after having fallen out of favor over the course of the prior 12 months. During that 12-month period, the price of oil had receded further from its most recent high watermark in July 2014. The Canadian oil patch and broader Canadian economy were struggling, pressuring the Canadian dollar as well.

Source: nasdaq.com

Canadian government finances and the country's exports were (and arguably still are) deteriorating. And Canadian households were (and inarguably still are) carrying the largest debt-to-income load in the entire G7, with household debt at almost 170% of disposable income.

Many Canadian households overindulged on near-record low interest rates in response to successive Bank of Canada cuts to its trendsetting lending rate and are funneling too much of their household budgets to debt repayment. And low interest rates, in turn, are squeezing the banks' margins.

Higher interest rates would ramp up the banks' loan stress levels, but the risk of higher rates appears to be slim to non-existent in the near term. In fact, it's conceivable we could see lower rates in Canada and remotely possible that rates could go negative, as they have in other countries.

I followed up the March 31 article on the Big Five Canadian banks collectively with successive articles on my three preferred Big Five banks, Toronto Dominion Bank on May 31, Bank of Nova Scotia on June 6, and, most recently, Royal Bank of Canada on June 21.

I enjoy researching and writing articles for Seeking Alpha. Investing is a hobby of mine, as is writing, and it is rewarding to be able to combine two hobbies, I enjoy to research and write on quality companies. Moreover, the Seeking Alpha editor who puts up with me is a joy to work with, and I continue to learn a great deal from her. I also continue to learn from the comments of Seeking Alpha readers of my articles. Collectively, your comments give me a prized opportunity to tap into the "wisdom of the crowds."

After publishing my recent article on Royal Bank, entitled Royal Bank Of Canada: A Jewel Of An Investment, a reader commented, "Not so sure it a jewel of a stock [sic] at these prices compared to what the price was a few months ago as it has appreciated 17% in an economy that is going nowhere."

The comment struck home for me how investing decisions must revolve around our investment and financial goals, which are as unique as we are.

For example, a retired individual like myself values safety in the form of preservation of capital, together with steady capital appreciation and growing dividend income to maintain my purchasing power. I look for attractively valued, large- to mega-cap dividend-growth stocks of companies with sound business models, strong management teams and wide economic moats - companies that are actually generating a lot of cash - What I call "Forever Stocks." I liken dividend-growth investing to something of a value tilt in disguise.

While it may be more exciting to search for "glamour stocks" - companies with big ideas, big growth expectations and high earnings multiples, I focus on steady and growing cash flows and high dividend growth. For example, I never owned Valeant (NYSE:VRX), which was a stock market darling not too long ago. I never really believed in the company's business strategy and, because I stayed away from the stock, I looked really dumb for some time. Growth-by-acquisition companies virtually never meet my elemental dividend-growth criteria.

Because of this, I miss the occasional homerun, but I also strike out less often. At this stage of the game, I don't need to pursue glamour stocks in an attempt to hit the ball out of the park; singles and doubles will suffice. But I do need to avoid striking out; that is, I need to avoid financial disasters. I define financial disaster - and risk - as permanent loss of capital.

I believe investors spend too much time thinking tactically instead of strategically. They want to know how to handle tomorrow, next week, next month, or next year in the markets, without planning for the next decade and longer. The challenge for most investors is adhering to an investment approach that enables them to capitalize on the long-term opportunity afforded by the markets, while not allowing short-term market gyrations to interfere with their long-term strategy. As Daniel Kahneman famously said in his Nobel acceptance speech, "The long-term is not where life is lived."

I have stuck to a long, long investment horizon. I believe that thinking and acting with a long-term perspective is paramount to an investor's success. When I make a decision to invest in a proportionate share of a business that displays the cardinal qualities I am looking for, then my ideal investment period is forever. Because I have a long investment horizon, I have the capacity to accept a higher level of volatility associated with a more significant weighting in equities.

I spent most of my career as vice president of investor relations for a number of public companies. As an investor relations professional, I conversed daily with institutional portfolio managers throughout North America and Europe. From this experience, I came to understand that individual investors with long investment horizons have an edge over professional money managers.

The "pros" are evaluated at least quarterly and are under pressure to make many more buy and sell decisions, at times for no other purpose than "window-dressing." This significantly increases costs and judgment errors. Individual investors are not under such pressure to swing at so many pitches.

A long investment horizon also helps me deal with the inevitable market gyrations; viz. last week's Brexit outcome (which I will cover more fully in the "Potential Risks" section of this article). By keeping a focus on the market's proven record to deliver positive returns over the long run, I am able tune out the noise of the day.

Because this long-term focus is my approach to investing, it is also my approach to the articles I write for Seeking Alpha. I have found through example that, if a reader's views differ from mine, it is nearly always because we have a different investment approach, most often around our respective investment time horizons.

As a result, for me, Royal Bank is a jewel of an investment, even if it may or may not be "perfectly priced" at the time the article was published. The same is true for Toronto-Dominion Bank and Bank of Nova Scotia. And there is nothing intrinsically wrong with Bank of Montreal (NYSE:BMO) or Canadian Imperial Bank of Canada (NYSE:CM). They are both solid banks - world-class banks by any measure. But because I prefer to own specific company stocks, rather than ETFs, three out of five is sufficient exposure for me to the Big Five banks. I have selected the three with the greatest diversity in their business models. (In full disclosure, I still own a small residual position in Bank of Montreal, which I have been trimming opportunistically.)

Investment Thesis

Since it has been three months since I wrote my initial article on the Big Five Canadian banks, I thought it would be useful to provide an update, as all five have reported their fiscal second quarter 2016 results during this three-month hiatus.

Canada's banking system is an oligopoly, with predominantly five large and protected banks serving the entire country. The Bank Act of Canada, which is administered by the Office of the Superintendent of Financial Institutions (OSFI), contains a prohibition preventing any "foreign bank" from engaging in or carrying on business in Canada. In stark contrast, the United States has a substantially greater competitive banking landscape, with over 6,000 banks and over 7,000...


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