Royal Bank of Canada (TSX:RY)(NYSE:RY) had an ugly Q4 2016,. The company missed analyst expectations by a whopping $0.07. Earnings per share dropped to $1.65 from $1.74 in the same quarter last year, and the bank cut its target following the disappointing earnings announcement.
This is the biggest bank of the Big Five and a core holding of many Canadian long-term investors because of its safety and high dividend yield, but after such an abysmal earnings report, is this stock going to pull back further, or is this simply a buying opportunity for value investors?
The stock dropped a whopping 3.37% on Wednesday as CEO Dave McKay announced that the company downgraded its return on equity (ROE) target from 18% to 16%. The lower ROE target was due to pressure caused by low interest rates combined with a large amount of uncertainty regarding regulatory requirements. McKay also stated that the new target will give Royal Bank of Canada more flexibility to grow its business abroad.
I don’t buy the excuses. All of the Canadian banks are in the same boat regarding low interest rates. While McKay tried to put a positive spin on the downgrade, I believe the company’s risk-management team isn’t doing the best job that they could be doing in the current economic environment.
Warren Buffett loves using the ROE of a company to determine whether or not its a business worth owning for the long term. The ROE is a very important measurement of how well a company can use a shareholder’s capital to turn into profits. A downgrade of 2% may not seem like much to the average investor, but I think this target downgrade is a much bigger worry than the earnings miss reported in this quarter.
Because of the missed earnings and the ROE downgrade, I believe the stock has further room to decline from here, but I also think the company is still a terrific forever stock for dividend investors. Following the quarter, I think the stock will pull back to lower levels, but value investors should start buying the stock once the dividend yield goes back above 4%.
The stock quite cheap right now, but it’s going to get a lot cheaper by the conclusion of 2016. If you’re a value investor looking to add a terrific forever stock that pays a safe and growing dividend, then look no further than Royal Bank of Canada.
The stock trades at a 13.1 price-to-earnings multiple with a 2.1 price-to-book multiple, both of which are in line with its five-year historical average values of 12.7 and 2.2, respectively. The dividend yield is also quite bountiful at current levels–a very fat 3.81%.
I believe it’s very possible that the stock could drop around the $80 level and yield over 4%. When it does, it would be a wise decision to pick up the stock at a huge discount to intrinsic value, because a 16% ROE is still very impressive.
