Royal Bank of Canada: Should You Buy or Bail?

Royal Bank of Canada (TSX:RY)(NYSE:RY) just hit a six-month low. Here’s why investors should be cautious right now.

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Royal Bank of Canada (TSX:RY)(NYSE:RY) has enjoyed a fantastic run in the past four years but the stock recently hit a six-month low and investors are wondering if this is the right time to buy, or book some profits and get out.

Let’s take a look at the current situation to see if you should add Royal Bank to your portfolio.

Earnings

In early December, Royal reported fiscal Q4 2014 earnings of $2.3 billion.

Canadian banking delivered net income of $1.2 billion, an 11% year-over-year gain, driven by strength in credit cards and mutual fund distribution fees. Deposits grew by 6% and loans increased by 4%.

Wealth management operations saw net income jump 41% compared to the same period in 2013.

Adjusted net income from the insurance division increased 14% compared to Q3 2014.

Capital markets net income dropped 14% year-over-year and fell by 37% compared to the third quarter.

Credit quality

Provisions for credit losses (PCL) hit their highest levels for the year but were still reasonable. The PCL ratio for the fourth quarter was 0.31%, with larger provisions for the Canadian and Caribbean residential mortgages accounting for most of the pain. Credit cards and personal lending write-offs were lower for the quarter.

Royal Bank had $192 billion in Canadian residential mortgages on the books as of October 31, 2014. Uninsured mortgages accounted for 60% of the portfolio.

Concerns for 2015

During the Q4 2014 conference call, the company’s chief risk officer, Mark Hughes, said credit card provisions are near historic lows. He also said the company is not seeing any deterioration in its residential mortgage portfolio and that 75% of mortgages now have fixed interest rates.

One item investors should watch carefully is the fact that 19% of Royal Bank’s outstanding residential mortgages are located in Alberta. With the oil industry facing a possible meltdown, the portfolio could start to see higher defaults in the second half of this year.

Capital markets activities accounted for about 22% of Royal Bank’s 2014 net income. Wealth management added another 12%. Revenues from these divisions can be volatile. When times are good, the company can deliver outstanding results, as it did in 2014, but earnings from these activities can dry up quickly.

Should you buy?

Royal Bank has increased its dividend by 50% in the past three years and the stock has gained more than 40% in the same time period. Much of the earnings growth has come from strong gains in the more volatile business segments and there is a risk that the numbers won’t be as robust this year. If that’s the case, dividend growth could slow down.

As a long-term bet, Royal is a good investment. However, the stock is in a downward trend and most of the Canadian banks, including Royal, have warned that 2015 will be tough. Royal Bank is probably a hold right now and new investors might see a better entry point in the coming months.

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.

Fool contributor Andrew Walker has no position in any stocks mentioned.

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