Diversify Your Canadian Bank Stocks

We advise most investors to place the bulk of their holdings in the Finance sector of their portfolio in two or more of the big five Canadian banks. The banks have been among the market’s top performers for several decades now, and continue to offer an attractive combination of growth and income.

We also recommend that investors diversify their Finance investments with non-bank Finance sector stocks, such as these four. Like the big banks, they trade at reasonable levels in relation to their earnings. Great-West Lifeco and IGM Financial also pay above-average dividends. However, we see only three as buys right now.

GREAT-WEST LIFECO INC. $32 (Toronto symbol GWO; Conservative Growth Portfolio, Finance sector; Shares outstanding: 894.4 million; Market cap: $28.6 billion; SI Rating: Above average) is Canada’s largest insurance company, with assets under administration of $392.8 billion. The company also provides retirement planning and wealth management services. Power Corp. controls 70.6% of Great-West’s shares.

The company recently sold its U.S. health care business for $1.3 billion. This business faces strong competition from larger insurers, whose size lets them negotiate better terms with medical service suppliers, so selling it made sense.

The cash will help Great- West fund last year’s purchase of struggling U.S.-based mutual fund manager Putnam Investment Trust. Putnam increases Great-West’s exposure to volatile stock markets. However, the acquisition gives it an opportunity to market its products to Putnam’s large client base.

Great-West’s earnings in the three months ended June 30, 2008 shot up to $1.36 a share (total $1.2 billion) from $0.61 a share ($544 million) a year earlier. If you exclude the gain on the sale of the U.S. health care operations and other non-recurring items, per-share earnings grew 3.3% to $0.63. Revenue grew 31.2%, to $5.4 billion from $4.1 billion.

Great-West holds $5.1 billion in securities linked to U.S. subprime mortgages and other risky assets. However, the chances of significant writedowns of these securities remains low.

The stock fell below $26 in July, 2008, but has gained 23% since then. It now trades at 13.0 times the $2.47 a share it will probably earn in 2008. The company also just raised its quarterly dividend by 5.1%, from $0.2925 a share to $0.3075. The new annual rate of $1.23 yields 3.8%.

Great-West Lifeco is a buy.

IGM FINANCIAL INC. $45 (Toronto symbol IGM; Conservative Growth Portfolio, Finance sector; Shares outstanding: 263.5 million; Market cap: $11.9 billion; SI Rating: Above average) is Canada’s largest independent mutual fund company, with $118.2 billion in assets under administration. Power Corp. controls 55.9% of IGM’s shares.

The company has three main divisions. Investors Group sells funds through its own network of over 4,000 financial advisors. Mackenzie Financial sells its funds through independent brokers. IGM also owns 74.5% of IPC Financial, whose 540 advisors provide a range of wealth management services.

IGM recently agreed to buy Saxon Financial Inc. for $287 million. Saxon provides wealth management services to individuals and institutions, and had $13.4 billion in assets under management at June 30, 2008. Saxon’s exclusive relationship with the Canadian Medical Association, holders of 30% of Saxon, also adds to its appeal.

To put the purchase price in perspective, IGM earned $216.1 million before unusual items in the second quarter of 2008. That’s up slightly from $215.9 million in the year-earlier quarter. Earnings per share were unchanged at $0.81. Revenue slipped to $721.1 million from $721.9 million.

IGM plans to maintain Saxon as a separate division, so savings from merging back office and other support operations may be slight. But the opportunity to market other products to Saxon’s medical clientele should spur long-term earnings.

The company will probably earn $3.30 a share in 2008, excluding Saxon. That implies a p/e of 13.6. IGM has also increased its quarterly dividend by 5.1%, from $0.4875 a share to $0.5125. The new annual rate of $2.05 yields 4.6%.

IGM Financial is a buy.

HOME CAPITAL GROUP INC. $35 (Toronto symbol HCG; Aggressive Growth Portfolio, Finance sector; Shares outstanding: 34.5 million; Market cap: $1.2 billion; SI Rating: Average) is the parent company of Home Trust Company, a federally regulated trust company. It provides financial services such as chequing accounts, mortgages and credit cards.

Home Capital is more risky than Great-West and IGM Financial. That’s because it focuses on customers that usually have trouble meeting the stricter lending requirements of larger banks. But we feel its strong growth prospects help offset this risk.

The company now aims to spur its growth by offering traditional mortgages. While that puts it in direct competition with the big banks, Home Capital feels this move will strengthen its position among mortgage brokers.

Meanwhile, the company continues to win new business away from competitors who have stopped making loans to riskier borrowers. In the three months ended June 30, 2008, earnings per share rose 20.6%, to $0.76 from $0.63 a year earlier. Mortgage loans rose 42.5%, while balances on its Equityline Visa credit cards grew 24.7%.

Despite targeting riskier borrowers than larger banks, Home Capital is doing a good job controlling credit losses. At June 30, 2008, bad loans represented just 0.71% of its total loan portfolio compared to 0.72% at the end of 2007.

The stock now trades at just 11.0 times its forecast 2008 earnings of $3.18 a share. The $0.52 dividend yields 1.5%.

Home Capital Group is a buy.

DUNDEE CORP. $13 (Toronto symbol DC.A; Aggressive Growth Portfolio, Finance sector; Shares outstanding: 74.6 million; Market cap: $969.8 million; SI Rating: Average) is a holding company with subsidiaries in three main areas: wealth management, real estate and resources. Its main asset is its 49% stake (63% voting interest) in DundeeWealth Inc., which offers wealth management services and owns the Dynamic family of mutual funds. DundeeWealth manages $63.1 billion worth of assets.

DundeeWealth recently completed its purchase of a 60% interest in Toronto-based pension fund manager Aurion Capital Management. It also acquired an 89% interest in BHR Fund Advisors, a Philadelphia-based mutual fund manager and distributor. The two purchases broaden Dundee- Wealth’s investment management capabilities, and diversify its sales distribution network.

In the three months ended June 30, 2008, Dundee Corp.’s earnings fell sharply, to $0.08 a share from $0.20 a year earlier. Revenue fell 8.5%, to $286.1 million from $312.6 million.

The lower earnings were mostly due to Dundee’s share of a loss on the sale of an investment by 53%-owned Eurogas Corp. As well, lower revenues from land sales hurt profits at Dundee’s real estate operations.

Dundee’s stock has moved down in the past few months due to fears of writedowns of illiquid securities held by DundeeWealth. As well, lower prices for oil, gold and other commodities could hurt the value of Dundee’s resource-related investments.

Dundee Corp. is a hold.