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The Reality Behind Bank of Montreal (TSX:BMO) Stock’s Impressive Q2 2021 Earnings

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The banking sector is riding on a strong rebound. Bank of Montreal (TSX:BMO)(NYSE:BMO) stock just reported strong fiscal Q2 financial results yesterday.

It experienced incredible growth rates across its diversified business that spans personal and commercial banking in Canada and the U.S., wealth management, and capital markets.

BMO stock’s key highlights for the first half of fiscal 2021

Here are the highlights of the solid bank’s results for the first half of the year.

It witnessed revenue growth of 8.7% to north of $13 billion. Adjusted net income increased by 77% to $4.1 billion. The provision for credit losses (PCL) ratio on impaired loans was 0.16% versus 0.32% in the first half of fiscal 2020, which helped lift earnings. Consequently, adjusted earnings per share climbed 79% to $6.19. Therefore, the payout ratio in the period was only 34%.

Adjusted return on equity was 16.3% versus 9.4% in the first half of fiscal 2020.

For fiscal Q2, BMO stock’s common equity tier-one ratio improved to 13% versus 11% a year ago. As Investopedia explains, this ratio measures a bank’s core equity capital, compared with its total risk-weighted assets, and signifies a bank’s financial strength. The higher the ratio, the stronger a bank’s financial strength.

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The reality behind BMO’s strong earnings

Currently, analysts estimate a whopping 49% growth rate in Bank of Montreal stock’s adjusted earnings per share this year. Given its results in the first half of the fiscal year, that estimate is not farfetched. However, it’s important to point out that the North American bank experienced an 18% decline in its adjusted earnings per share in fiscal 2020. And the high growth rate is coming off from that disrupted earnings.

If the 49% growth rate estimate materialized, it would translate to a growth rate of about 8.9% from fiscal 2016 to 2021, which is much less impressive but displays a clearer picture of the kind of stable growth rates that big Canadian banks provide over a longer period. This also explains why the bank stock didn’t rally to the moon but instead only appreciated 1.46% on the day.

In the Q2 2021 earnings call, BMO’s chief risk officer Pat Cronin stated that “In terms of impaired loan losses, given the strength of current credit conditions, and the near term economic outlook, we may see the next few quarters continue with low credit losses. Looking into fiscal 2022, our expectation is that impaired loan losses will normalize and average in the range of low 20’s in terms of basis points.”

The normalization of the PCL ratio on impaired loans is anticipated to dampen earnings in fiscal 2022, but not to the extent that occurred in fiscal 2020.

What should investors expect from BMO stock going forward?

As mentioned earlier, BMO stock’s payout ratio is at its historic low. This is thanks to a resurgence in its earnings and a quarterly dividend that had stayed the same for seven quarters thus far. If you’ll recall, before the pandemic, the bank used to increase its dividend every half a year.

Once regulators lift the ban, the robust bank will have no problem increasing its dividend at a nice rate. My guess is dividend increases will be in the 7% range — a rate that aligns with its medium-term earnings-per-share growth rate of 7%.

BMO stock is reasonably valued today. On a 7% growth rate and a 3.4% dividend, the safe bank stock can deliver long-term annualized returns of about 10% assuming no valuation expansion or compression. If you’re skeptical about its growth rate estimate, you might pare it down a notch and estimate a rate of return of about 8% instead.

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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.

Fool contributor Kay Ng has no position in any of the stocks mentioned.

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