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2 Reasons to Avoid Royal Bank of Canada, and 1 Stock to Buy Instead

These days, it’s tough to find anything negative to say about Royal Bank of Canada (TSX: RY)(NYSE: RY). Canada’s largest bank (and largest company overall) is firing on all cylinders and generating record profits. It is well capitalized, especially by international standards, and there are no signs of any of this changing.

But that does not mean you should jump on board instantly. Below we take a look at two reasons to avoid shares of RBC and one stock to buy instead.

1. Unforeseen risks

There are a couple of issues to talk about here. One is the bank’s exposure to riskier business lines, especially capital markets. Recently, this exposure has been a big positive — net income in capital markets was up 66% year over year, and now accounts for a quarter of overall earnings. But this is an area where volatility is very high and transparency is not. When the market is going RBC’s way, no one seems to mind. But things can change very quickly, and shareholders must be willing to take that risk.

Secondly, RBC has a big exposure to Canada, with about half of income coming from Canadian banking. And plenty of concerns remain about the Canadian market — real estate prices appear
overheated, and consumers remain very indebted.

2. Expensive share price

RBC’s success has not gone unnoticed by the market, with the shares up 44% in the last two years alone. Unfortunately, that means its shares are trading at lofty levels. In fact, they are trading at 2.5 times book value, the highest of any of the Big 5 banks.

So, in order for the shares to continue doing well, the bank needs to keep all of its momentum going. This is no guarantee.

1 stock to buy instead: The Bank of Nova Scotia

If you’re looking for a Canadian bank to anchor your portfolio, a better option appears to be The Bank of Nova Scotia (TSX: BNS)(NYSE: BNS). There are numerous reasons.

First, The Bank of Nova Scotia is very well diversified, with only 34% of net income coming from Canadian banking. In fact, only 52% of earnings came from Canada overall, the lowest ratio of any Canadian bank. Meanwhile, a big chunk of earnings comes from emerging markets, specifically Latin America. This exposure gives the bank plenty of opportunities to grow earnings, and do so in a very transparent way.

Secondly, The Bank of Nova Scotia is much cheaper than RBC, trading at 2.0 times book value. On a price/earnings basis, the former is again cheaper, trading at 12.2 times while the latter trades at 13.4 times. The Bank of Nova Scotia also has a slightly higher dividend yield, at 3.6%, compared to RBC’s 3.5%.

So when choosing between these two banks, it should be clear which one is right for your portfolio. Anyone looking for more information can find it in the free report below.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

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