Canadian bank stocks are often among the first investments Canadians consider when they want reliable dividends, and for good reason.
The banks have earned that reputation over decades by consistently generating billions in profit and finding multiple ways to grow and generate cash flow. That stability has rewarded shareholders for years.
And their latest earnings gave investors another reason to be confident, as all six of Canada’s largest banks beat analysts’ profit expectations.
However, if you’re thinking about buying one today, strong earnings are only part of the picture. Bank stocks have already had a significant run, and some of the recent growth came from businesses that benefit when financial markets are strong.
So, the question is whether a particular bank can keep growing enough to justify the price you’re paying for its shares.
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What the latest results tell us about bank stocks
One of the biggest strengths of Canada’s banks is that they don’t rely entirely on collecting interest from loans.
Royal Bank of Canada (TSX: RY), for example, reported record quarterly net income of $6 billion in its most recent quarter, up 11% year over year. Wealth management and capital markets helped drive that growth alongside its traditional banking operations.
Meanwhile, Toronto-Dominion Bank (TSX: TD) reported adjusted earnings of $4.7 billion, up 21% from a year earlier as its Canadian banking business continued growing, while its U.S. and wholesale banking operations also delivered stronger results.
That diversification is a major reason why Canadian bank stocks are some of the most reliable and popular stocks Canadians buy and hold for the long haul.
With that said, investors shouldn’t assume that trading activity, investment banking and rising asset values will boost earnings at the same pace every quarter.
Furthermore, it’s also important to keep an eye on the loans banks already have. For example, higher mortgage payments, trade uncertainty and slower economic growth could put pressure on borrowers, even if the banks are reporting strong profits today.
So far, most Canadians renewing their mortgages have managed the increase, and lenders haven’t seen a broad rise in loan losses.
However, the Bank of Canada expects the remaining group of borrowers renewing five-year mortgages taken out during the pandemic to face payment increases averaging about 15%, so there are still considerable risks investors need to be mindful of.
Strong businesses can still be expensive stocks
Because bank stocks are so reliable and such popular investments among Canadians, they also often trade at a premium, which makes valuation another important factor to consider.
Around the time the banks reported their latest earnings, Canada’s largest lenders traded at an average of roughly 15 times forward earnings, their highest valuation since 2010.
So, even if these banks continue to perform well in the near term, their share prices can still struggle when expectations are already that high.
That’s why, rather than trying to figure out which bank stock is the best in the current environment, many investors prefer to buy the BMO Equal Weight Banks Index ETF (TSX: ZEB) for exposure to the sector.
The ETF holds Canada’s six largest banks at roughly equal weights, giving investors exposure to RBC’s diversified business, TD’s potential recovery, and the rest of the sector in one investment.
Plus, ZEB pays monthly distributions and offers a current yield of 2.4%, so you can still collect income while owning all six banks.
So, if you’re looking to buy Canadian bank stocks today, you’ll want to keep their recent rally and higher valuations in mind.
With that said, if you’re investing for the long haul and your portfolio already has plenty of exposure to other sectors, there’s nothing wrong with owning high-quality Canadian banks in the current environment.
