Royal Bank of Canada has fallen during five of the past six trading days, as of Thursday.Supplied
Perhaps we should get used to expensive bank stocks.
The shares of Canadian lenders ripped higher after October, 2023, when widespread concerns about the impact of inflation and rising interest rates began to subside. Bank stocks have more than doubled since then, on average.
That’s unusual for lumbering, regulated behemoths. While the sector tends to outperform the S&P/TSX Composite Index over the long term by a slim margin, it has beaten the index by an overwhelming 30 percentage points over the past two-and-a-half years.
Normally, big gains aren’t worth complaining about.
But the rally has pushed valuations to levels that are now well above long-term averages. And these elevated valuations raise questions about whether the sector could hit an air pocket if the sputtering Canadian economy gets worse or a protracted Middle East conflict drives up global inflation.
Over the past week, bank stocks have not been immune to the broader market turmoil.
Royal Bank of Canada, the largest lender, has fallen during five of the past six trading days, as of Thursday. The share price is down nearly 6 per cent from its high in late February, when the banking sector reported its quarterly financial results.
Perhaps rattled investors are taking a closer look at valuations.
RBC trades at 14.1-times estimated profits for 2026, according to S&P Global Market Intelligence. That’s up from a price-to-earnings ratio of 10.5 shortly before the rally began in 2023 and above the 10-year average of 11.9.
Even Toronto-Dominion Bank, whose share price was slaughtered in 2024 over a U.S. regulatory ruling against the bank’s anti-money laundering practices, is looking rich after a sharp rebound over the past year.
TD trades at 13.9 times estimated 2026 profits, up from a P/E ratio of 10 in late 2024. That’s also well above the 10-year average of 11.2.
Looking for a bargain in the group? That would be Bank of Nova Scotia, at 12.6-times estimate earnings. But it, too, is trading well above its 10-year average valuation.
Dividend yields offer similar concerns. The average yield among the Big Six has slipped below 3.3 per cent. That’s approaching the lowest level in decades and down from more than 5.6 per cent in October, 2023.
National Bank of Canada’s yield, the lowest of the group, now sits at just 2.6 per cent.
But here’s a thought: What if these elevated valuations are okay given that banks are delivering on lofty expectations?
The largest Canadian lenders are squeezing more profits out of their diverse operations, arguably justifying the undeniably rich valuations. And that adds a compelling argument for staying put in the sector – or even adding to them.
Market Factors: Why it might not be a good time to buy bank stocks
In their fiscal first-quarter financial results, released at the end of February, the Big Six reported a combined profit of nearly $19-billion, up 33 per cent from the same period last year, adding some justification for the higher P/E ratios and lower dividend yields.
Their profits, on a per share basis, beat analyst expectations by an average of 8.6 per cent.
That not only adds to the allure of bank stocks as strong performers. It supports the case that their businesses can plough through an uncertain economic backdrop, lingering trade tensions and simmering concerns about loan losses as mortgages renew at higher rates.
The banks’ use of artificial intelligence tools in their daily operations promises to improve efficiency and give them greater control over loan losses, potentially boosting profitability.
“AI is helping protect our bank by strengthening fraud prevention, credit monitoring and anti-money laundering functions,” Harry Culham, CIBC’s chief executive officer, said during a call with analysts last week.
Sure, the Canadian economy contracted 0.6 per cent in the fourth quarter, on an annualized basis, which isn’t great news for a sector that reflects its activity.
But some experts believe the economy is showing resilience in the face of tariffs, and the contraction was a one-off technical issue related to the build-up of inventories last year.
What’s more, Ottawa is now making bold plans to build infrastructure and pursue new trade opportunities that could make Canada attractive to global investors, and spur the sort of financial activities that define banks.
For what it’s worth, bank CEOs who have the pulse of the economy are believers.
“Going forward, we expect increased fiscal stimulus, and the diversification of new trading relationships to create a multiplier effect of supporting economic growth and client activity over the near- to medium-term,” Dave McKay, RBC’s CEO, said during a conference call with analysts.
You want to bet against that assessment because of elevated P/E ratios? Good luck.