Monday, 22 August 2011

Bank Stocks: Alternative Ways to Invest

Many investors these days are casting their eyes towards the Canadian banks for any number of reasons: generally they are in good shape; they are amongst a raft of stocks offering attractive looking valuation numbers as we remarked in last week's Summer Stock Sale post; and finally, they have above market average dividend yields, which even have the potential to go up further according to this GlobeInvestor article looking ahead to their quarterly earnings reports of the next few weeks.

For those interested, there are three main ways to invest in bank stocks:

Common shares -
Very straightforward, what you see is what you get. There are no extra management fees or expenses and they currently offer higher dividend yields than Split Capitals, as our comparison table below shows. There is no leverage either in common shares (of course, banks themselves use leverage internally and that is one of the risk factors for the common shares but we are referring to leverage applied by the investor in making the investment).

ETFs and
Mutual funds - Among ETFs, the most concentrated is BMO's S&P/TSX Equal Weight Banks Index ETF TSX: ZEB, which only holds the big six banks in equal proportions. The iShares S&P/TSX Capped Financials Index Fund (TSX: XFN) contains healthy doses of bank shares but in the interests of diversification, it holds a much wider mix of stocks than just bank stocks, such as insurers and investment companies. Neither of these ETFs apply any leverage. There is an ETF with leverage, the Horizons BetaPro S&P/TSX Capped Financials Bull+ ETF (TSX: HFU) but it is quite a different animal, a tool only for the day trader since its returns equal 200% of the daily performance of the index.

Split Capital corporations
- These are companies with the sole function of investing in stocks. The split share corporations issue preferred shares paying a fixed dividend rate, which in effect is borrowed money from the perspective of the capital share owners (see our previous posts on Split Capital Shares and Split Preferreds for more explanation how each works). Through this, Split Capital shares have the unique property of leverage, which amplifies gains - and losses too, raising their riskiness. The Split's leverage may thus be of special interest now if the banks are now back on a growth path. Dividend growth by the banks will also accrue only to the benefit of Split Capital owners since Split preferred share dividends are fixed.

Split shares currently a mixed bag of attractive and scary -
  • Scary - Original Commerce Split (TSX: YCM.X) and New Commerce Split (TSX: YCM.A), both based on CIBC, look destined to produce large losses for an investor today - a negative Net Asset Value (NAV) and a price far above it. The Split corporation is not even able to pay the Preferreds' dividends. A little less scary but still quite worrisome is TDb Split Corp. (TSX: XTD), trading at a value almost 75% above its NAV.
  • Attractive - Again, based on the view that bank shares and dividends are on the upswing, two of our list look best to us - Allbanc Split Corp. II (TSX: ALB) which holds more or less equal proportions of the top six banks and 5Banc Split Inc. (TSX: FPS), which holds only the big five and not National. Both have higher leverage, promising a bigger boost if the banks do well. Both have a fairly good discount of market price to NAV of about 7%, which provides some downside protection and the extra upside potential that the price may move closer to NAV. Both are also healthy enough to pay a decent dividend rate to the Capital shareholders as well as the required dividends to the Preferred shares. Though FPS is due to be redeemed and go out of existence December 15th this year, its managers TD Securities earlier this year announced an intention to examine the extension of the corporation's life. Amongst the single underlying stock Splits, the Royal Bank based R Split III Corp. (TSX: RBS) looks reasonably good - 7.8% discount to NAV and wrap-up scheduled for May 2012 which means that discount must be eliminated by then; decent dividend of 2.7%; and lots of leverage 2.5x though in this case the nearby wrap-up date means the stock price has to move up by then for the benefit to be gained. RBS is a play on short-term expectations.
Canadian Bank Share Alternatives Comparison

With bank stocks down along with the market these days, it takes fortitude to go ahead and invest. The investor must make the fundamental choice between the risk and possible reward of equity investment versus the stability of GICs and such. But for those who want to take the plunge, the alternatives are there.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

1 comment:

Anonymous said...

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