Why it’s Not the Best Time to Buy the Big Banks

There’s no question that the big banks in Canada are quality companies. In fact, the Big Five banks were the most profitable Canadian companies in 2015.

To keep this article brief and to the point, the focus will be on the most profitable banks: Royal Bank of Canada (TSX:RY)(NYSE:RY) and Toronto-Dominion Bank (TSX:TD)(NYSE:TD).

Long-term earnings growth

Looking back in history, Royal Bank of Canada and Toronto-Dominion Bank have had long-term trends of growing their earnings in the last two decades. In fact, they were profitable every year–they didn’t have negative earnings in a single year.

Since right before the financial crisis (i.e., the fiscal year 2007) to 2015, Royal Bank of Canada and Toronto-Dominion Bank compounded their earnings per share (EPS) by 5.9% and 6.1% per year, respectively.

These were higher growth rates compared to the remaining Big Five banks, which compounded their EPS by 1.3-4.5% per year during that period.

Stable, growing dividends

The big Canadian banks are known for their quality, financial strength, and stability. And their steady earnings growth has led to safer dividends.

From the fiscal years 2007 to 2015, Royal Bank of Canada and Toronto-Dominion Bank compounded their dividends per share (DPS) by 6.8% and 8.4%, respectively.

Both leading banks expanded their payout ratios, but the latter had a lower payout ratio in 2007 and higher subsequent earnings growth that led to faster-growing dividends.

These were higher growth rates compared to the remaining Big Five banks, which compounded their DPS by 2.3-5.7% per year during that period.

The banks’ dividends remain safe with payout ratios of less than 50%. Specifically, in the fiscal year 2016, Royal Bank of Canada’s and Toronto-Dominion Bank’s payout ratios are expected to be about 48% and 45%, respectively. And the remaining Big Five banks’ payout ratios are expected to be 46-49%.

So what?

If Royal Bank of Canada, Toronto-Dominion Bank, and the other big Canadian banks are growing their earnings and dividends, why is it not the best time to buy their shares?

The answer is simple. There’s no margin of safety for an investment today. The banks are trading near their 52-week highs. Based on their normal trading multiples, the banks are at best trading at fair valuations.

As the stock market is near its high, interested investors can be a little more cautious by preserving their capital. Instead of buying the banks at fair valuations, they can wait for pullbacks to buy at discounted valuations to get higher starting yields and likely higher long-term returns.

Stock buy alert hits astounding 96% success rate!

The hand-picked investing team inside Stock Advisor Canada recently issued a buy alert for one special type of “bread-and-butter” stock where The Motley Fool U.S. has banked profits on 23 out of 24 recommendations. Frankly, with an astounding 96% success rate that has delivered average returns of 260%, chances are this new pick could deliver life-changing returns as well. Because the team at Stock Advisor Canada fully embraces the same time-tested investing philosophies that have led to countless Motley Fool winners globally. So simply click here to unlock the full details behind this new recommendation and join Stock Advisor Canada.

*96% accuracy includes restaurant stock recommendations from Motley Fool U.S. services Stock Advisor, Rule Breakers, Hidden Gems, Income Investor and Inside Value since each services inception. Returns as of 5/27/16.

Fool contributor Kay Ng owns shares of  Toronto-Dominion Bank.

I consent to receiving information from The Motley Fool via email, direct mail, and occasional special offer phone calls. I understand I can unsubscribe from these updates at any time. Please read the Privacy Statement and Terms of Service for more information.