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david berman

A Canadian Western Bank branch in Calgary. This year CWB has gained nearly 37 per cent, which is more than double the return on the S&P/TSX composite index and better than all of the Big Six banks.Reuters

The case for investing in a big bank is easy: Buy shares, fall asleep for 20 years, wake up wealthy. But what's the case for investing in the little guys?

Laurentian Bank of Canada and Canadian Western Bank don't receive nearly the level of attention of, say, Royal Bank of Canada and Toronto-Dominion Bank. Yet, they hold appeal for investors who don't mind sacrificing diversification for lower valuations.

This year Canadian Western Bank has gained nearly 37 per cent, which is more than double the return on the S&P/TSX composite index and better than all of the Big Six banks. Even better, from CWB's low point in the year, in February, the shares have surged more than 60 per cent.

Laurentian Bank's recent performance isn't as wow-inducing, but it is the cheapest bank stock you can buy (based on its price-to-earnings ratio), it comes with a big 4.4-per-cent dividend yield, and it outperformed RBC between 2014 and 2016, when investors were concerned about the impact of tumbling oil prices.

In other words, small banks can dazzle when you get the timing right.

By "small" we are referring to publicly traded bank stocks that do not count among the Big Six, which control more than 90 per cent of the market in Canada.

The difference between these smaller players and the big banks is vast: The combined value of Canadian Western Bank and Laurentian Bank is just $4.7-billion, or a quarter of the size of National Bank of Canada, the smallest of the Big Six. Put another way, RBC's trading activities alone drive more revenue than Laurentian and CWB's entire banking activities.

This small size brings significant disadvantages when the regional markets in which these small banks operate aren't doing well.

But the inverse is also true. CWB, whose traditional base is in Alberta, has risen sharply with the rebound in the price of oil; it also outperformed when oil rose between 2009 and 2011. Laurentian, based in Quebec, performed better than its larger peers when oil was falling between 2014 and 2016: It had no loans to energy companies and the Quebec economy was poised to benefit from cheap energy and a low Canadian dollar.

Over the longer haul, being small hasn't always worked out. Over the past five years, both Laurentian Bank and CWB lagged the S&P/TSX banks index by a wide margin.

However, both stocks have kept up with the S&P/TSX composite index over the past 10 years, suggesting that even if you get the timing wrong, small banks can at least keep up with a big basket of Canadian stocks.

Today, smaller banks may have a couple of advantages, too. For one, they haven't been designated by financial regulators as systemically important. That means they are not too big to fail – but it also means that they don't have to satisfy various regulatory requirements related to capital, which can dampen growth.

Secondly, the big banks are slowly discovering that their vast physical branch networks are not especially helpful when most consumers are making transactions on their smartphones and computers.

Smaller banks, with fewer branches, now look leaner – and they are faster at adapting to changes. In September, Laurentian Bank announced plans to close 50 branches – or nearly a third of its total – over 18 months, which is far more drastic than any branch closures announced by the bigger banks.

The cuts may be paying off. In its fourth-quarter results, released on Tuesday, the bank said that its profit rose 15 per cent, to $50.5-million, after adjusting for costs related to branch closures (and layoffs). That's stronger growth than any of the Big Six.

Some analysts are now raising their estimates. Darko Mihelic, an analyst at RBC Dominion Securities, estimates that the shares should trade at nine times earnings, up from a previous estimate of 8.5 times earnings.

"We have increased our target multiple to reflect increased confidence that Laurentian Bank can reduce its expense base and improve efficiency," he said. "While we would like to study Laurentian's cost situation further, we could see further upside to our estimates from cost reductions."

Perhaps it's time for small-bank investors to dream big.

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 27/03/24 4:00pm EDT.

SymbolName% changeLast
CWB-T
CDN Western Bank
+1.66%28.2
LB-T
Laurentian Bank
+1.82%28.5
RY-T
Royal Bank of Canada
+1.12%136.23
RY-N
Royal Bank of Canada
+1.26%100.4
TD-T
Toronto-Dominion Bank
+1.52%82.27
TD-N
Toronto Dominion Bank
+1.69%60.64

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