Bank of Nova Scotia - A Case Study of PE

Often you have to be careful with PE analysis. For example, Bank of Nova Soctia is currently trading at $29.86 and has a PE of 9.77 (EPS of $3.05).

On the surface, it would seem that BNS is undervalued based on PE analysis.

However, if you look at their annual reports, the reason for the heavy discount is (as everyone knows) that the banks have been suffering more than most in this economy because of the credit crisis. Their EPS in the last quarter was only 28c ($315 m) and they had $642 m in write offs which hit the bottom line very hard. However, the weight of the last dismal quarter is (obviously) just one quarter of the EPS.

EPS here looks to be in decline. But this is the point of importance is that people aren't sure how much (hence lack of confidence) and the earnings (although reported at $3.05, I would estimate for short term valuations should be more likely closer to 2.5). Having said that, suddenly the PE ratio is closer to 12 given the current economic estimates (not just historical EPS) and BNS is not as discounted as you would think.

The result? It's still an "ok" buy. But will probably drop a bit more as people expect bad news (6 to 9 months). Hence the 3 - 5 year out look for most Canadian banks.