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The average bank has a dividend yield of around 2.5% SPDR S&P Bank ETF (NYSEMKT: KBE) as a sector proxy. What if you could own a bank with a 6.1% yield? What if it was run conservatively, had a strong core business and was a reliable dividend payer? You would probably jump at the chance to own such a high-yield bank. No problem: you can buy Bank of Nova Scotia (NYSE:BNS). Here’s why now is a great time to take the plunge.
Why are the Bank of Nova Scotia’s returns so high?
Bank of Nova Scotia, better known as Scotiabank, has lagged behind other banks. A big part of the reason for this is that it took a different strategic direction than its Canadian banking peers. Most major Canadian banks chose to expand south into the US market. Scotiabank skipped the U.S. and began building a business in Central and South America.
The logic is sound as the US is a highly competitive market that is also fully developed. The markets Scotiabank entered were developing and less competitive, suggesting there is potential for longer-term growth. While that may have been true, and may still be true, these less developed markets were not as profitable as hoped. Scotiabank has lagged behind its peers on key measures such as earnings growth, return on equity and return on risk-adjusted assets.
Despite being one of the largest banks in Canada (with a strong position in the industry thanks to strict Canadian banking regulations), Scotiabank offers a dividend yield of 6.1%, more than twice the yield of the average bank. The bank has paid dividends every year since 1833, has a generally conservative ethos (another feature of a Canadian bank) and has an investment grade-rated balance sheet. Indeed, the risk here seems quite modest for the high-yield reward.
What is Scotiabank doing about its lagging performance?
The problem for investors, of course, is that Scotiabank hasn’t performed particularly well compared to its peers. But management is not ignoring the problem. In fact, she has taken a closer look at the issue and is working in a new direction. It is leaving weaker markets (such as Colombia) and making more efforts to expand in better markets (such as Mexico). The company is also following its peers in building a larger presence in the United States.
The latter is important for Scotiabank’s approach, because it wants to create a dominant North American bank that reaches from Mexico to Canada and via the United States. In this way it can serve a regional trading bloc with a geographically integrated product. This is where Scotiabank just made a big splash.
Instead of trying to build a company from the ground up, it agreed to buy just 15% of it KeyCorp (NYSE: KEY). The move will take place in two transactions and is expected to be immediately accretive to Scotiabank’s revenues. Moreover, it provides a lifeline for KeyCorp, which has needed to shore up its own finances. This is actually a win/win situation. However, the real benefit will likely be longer term.
Right now, Scotiabank’s investment is just that: an investment in another bank. However, it hopes it can find ways to work with KeyCorp to jointly offer products and services. Notably, KeyCorp is more consumer-oriented, while Scotiabank is more business-oriented, so the two banks won’t step on each other’s toes. Each partnership would complement the activities of each bank.
There is a five-year standstill clause in the agreement, so KeyCorp cannot do much more than this for the time being. However, it’s hard not to imagine that Scotiabank would at least consider a buyout of KeyCorp at some point in the future – a move that would immediately give it a major presence in the US market.
The future will look very different for Scotiabank
Investors should never invest too much in an investment like Scotiabank’s. But it is a clear statement that management plans to make dramatic and rapid shifts in its quest to narrow the performance gap with industry peers. It will certainly be a multi-year effort. But with such a strong push from a financially strong high-yield bank, investors who think about decades and not days might want to act now. That fat dividend yield may not last as long as you think if Scotiabank’s business starts to turn around amid an aggressive drive to improve performance.
Should You Invest $1,000 In Bank Of Nova Scotia Now?
Consider the following before buying shares in Bank Of Nova Scotia:
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Ruben Gregg Brouwer has positions in Bank Of Nova Scotia. The Motley Fool recommends Bank Of Nova Scotia. The Motley Fool has one disclosure policy.
Did this high-yield stock just change the playing field? was originally published by The Motley Fool