The bank’s average dividend yield is around 2.5%, using SPDR S&P Bank ETF (NYSEMKT: KBE) As a proxy for the industry. What if you could own a bank that yielded 6.1%? What if it was conservatively run, had a strong core business, and was a reliable source of dividends? You might jump at the chance to own a high-yielding bank like that. No problem — you can buy shares in another bank. Bank of Nova Scotia (NYSE: BNS)Here’s why now is the right time to take the plunge.
Why is the yield on Bank of Nova Scotia so high?
The Bank of Nova Scotia, better known as Scotiabank, has lagged behind other banks. In large part, it has taken a different strategic direction than its Canadian peers. Most of Canada’s major banks have chosen to expand south into the U.S. market. Scotiabank has skipped the U.S. and begun building businesses in Central and South America.
The logic is sound, given that the U.S. is a highly competitive and fully developed market. The markets Scotiabank went into were developing and less competitive, suggesting potential for further growth over the long term. While that may have been true, and perhaps still is, these less developed markets were not as profitable as expected. Scotiabank lagged its peers on key metrics such as earnings growth, return on equity, and return on risk-adjusted assets.
So despite being one of Canada’s largest banks (with a well-established position in the industry thanks to Canada’s strict banking regulations), Scotiabank offers a dividend yield of 6.1%, more than double that of the average bank. It has paid a dividend every year since 1833, has a generally conservative ethic (another function of being a Canadian bank), and has an investment-grade balance sheet. The risks here seem rather modest for the high reward.
What is Scotiabank doing about its lagging performance?
The problem for investors, of course, is that Scotiabank has not performed particularly well compared to its peers. But management is not ignoring the problem. In fact, it has addressed the problem head-on and is moving in a new direction. It is exiting weaker markets (such as Colombia) and expanding into better ones (such as Mexico). The company is also following the lead of its peers by building a larger presence in the United States.
The last part is important to Scotiabank’s approach, because it wants to create a dominant North American bank that stretches from Mexico to Canada and across the United States. That way, it can serve a regional trading bloc with a geographically integrated product. And that’s where Scotiabank is making a splash.
Instead of trying to build a business from the ground up, I agreed to buy about 15% of K Corp (NYSE: KEY)The move will be done in two transactions and is expected to immediately boost Scotiabank’s earnings. Additionally, it provides a lifeline to KeyCorp, which has been in need of its own financial resources. This is essentially a win-win situation. However, the real benefit is likely to be long-term.
For now, Scotiabank’s investment is little more than an investment in another bank. However, the bank hopes to find ways to work with KeyCorp to offer products and services together. KeyCorp is more consumer-oriented while Scotiabank is more business-oriented, so the two banks will not interfere in each other’s business. Any partnership would add to each bank’s business.
There’s a five-year lock-in clause in the agreement, so KeyCorp can’t do much more than that at the moment. Still, it’s hard not to imagine that Scotiabank might at least consider buying KeyCorp at some point in the future — a move that would immediately give it a significant presence in the U.S. market.
The future looks very different for Scotiabank.
Investors shouldn’t overstate the significance of Scotiabank’s recent investment. But it’s clear that management intends to change course dramatically and quickly as it seeks to narrow the performance gap with its peers. That effort will certainly take years. But with such a strong push from a financially strong, high-yielding bank, investors who think in terms of decades rather than days may want to invest now. That huge dividend yield may not last as long as you think if Scotiabank’s business starts to turn around amid an aggressive effort to improve performance.
Should you invest $1,000 in Bank of Nova Scotia now?
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Robin Greg Brewer He has positions at Bank of Nova Scotia. The Motley Fool recommends Bank of Nova Scotia. The Motley Fool has Disclosure Policy.
Is this high-yield stock a game changer? Originally posted by The Motley Fool