Bank of Nova Scotia (TSE:BNS) (NYSE:BNS), also known as Scotiabank, is one of the largest and oldest Canadian banks. It also recently earned a ‘Perfect 10’ Smart Score rating, meaning that it has a high chance of outperforming the market. Despite its not-so-perfect financial outlook, its Smart Score, generous 6% dividend yield, and inexpensive valuation (8.5x P/E ratio and 8.2x forward P/E), point to solid future returns.
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BNS’ Dividend is Outstanding
A 6% dividend yield is definitely eye-catching. What’s even more eye-catching is its resiliency. The company has continuously paid dividends since 1833, and it has raised its dividend in 43 of the past 45 years. Over the past five years, its dividend has grown at a 5.9% compound annual growth rate (CAGR), which is impressive for a 6%-yielding stock. Its payout ratio is also near 50%, meaning the company’s dividend is very well covered and can be sustained even if earnings fall substantially.
This Calculation Shows Why BNS Stock is Undervalued
To value Bank of Nova Scotia, we will use the excess returns model, which is more appropriate for financial companies because they tend to have volatile free cash flows.
As a result, trying to create forecasts for them is ineffective. The excess returns model allows us to use historical numbers instead, which are actual results. There are a few steps to follow for this valuation method.
First, you calculate a company’s excess return, meaning the spread between its return on equity (ROE) and its cost of equity; a higher ROE than the cost of equity is a good thing. Next, you calculate its terminal value. Add them up, and you get your valuation. Here’s the formula:
- Excess Return = (Average ROE – Cost of Equity) x Book Value Per Share
- Terminal Value = Excess Return / (Cost of Equity – Growth Rate)
- Fair Value = Book Value Per Share + Terminal Value
We will use the following assumptions for our calculations:
Average return on equity (ROE): 12.8% (five-year average)
Cost of equity: 8.4%
Book value per share: C$61.21
Growth rate: 2.87% (used 30-year Government of Canada bond yield as a proxy for long-term growth expectations)
Now that we have our assumptions, we’ll plug them into the formula highlighted above. The numbers are in Canadian dollars:
- $2.693 = (0.128 – 0.084) x $61.21
- $48.70 = $2.693 / (0.084 – 0.0287)
- $109.91 = $61.21 + $48.70
Therefore, BNS stock is currently worth C$109.91 as per this valuation method. Its current share price is near C$68, making it undervalued.
Is BNS Stock a Buy, According to Analysts?
According to analysts, BNS stock comes in as a Hold based on just one Buy and seven Hold ratings assigned in the past three months. Nonetheless, they also think it’s undervalued, as the average BNS stock price target of C$80.32 implies 17.8% upside potential.
Conclusion: Consider Buying BNS Stock
Scotiabank is a very resilient Canadian bank that has consistently paid dividends for nearly two centuries. With BNS, you get an undervalued stock with a high, relatively safe, growing dividend yield. The ‘Perfect 10’ Smart Score is the cherry on top.
