RBC (TSX:RY) Stock’s Jump in Q2 2021 Earnings Explained

The banking sector is experiencing a big comeback. The big Canadian banks’ earnings were disrupted last year during the pandemic, particularly in fiscal Q2. As a result, Royal Bank of Canada (TSX: RY)(NYSE: RY) stock reported strong fiscal Q2 financial results yesterday compared to the prior year’s quarter.

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

RBC 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 6.0% to approximately $24.5 billion. Net income increased by 58% to $7.8 billion. Quarterly earnings made a huge improvement due to abnormally high provision for credit losses (PCL) during fiscal Q2 2020. Earnings also benefited from constructive markets and strong volume growth, partially offset by low interest rates and higher expenses primarily due to variable and stock-based compensation proportionate to strong results.

This translated to diluted earnings per share growth of 59% to $5.42 in the first half (H1) of the fiscal year, resulting in a payout ratio of about 40% in the period. Its return on equity was 19.0% versus 12.5% in the first half of fiscal 2020.

In H1 2021, RBC stock’s common equity tier-one ratio improved to 12.8% versus 11.7% a year ago. As Investopedia explains, this ratio measures a bank’s core equity capital, compared with its total risk-weighted assets, and indicates a bank’s financial strength. The higher the ratio, the stronger a bank’s financial strength.

The reality behind Royal Bank’s strong earnings

Currently, analysts estimate a whopping 29% growth rate in RY stock’s adjusted earnings per share this year. Given its results in H1 2021, it should be easy for RBC to realize that estimate. However, it’s important to point out that the North American bank witnessed a 12% decline in its adjusted earnings per share in fiscal 2020. And the high growth rate is coming off from that disrupted earnings.

If the 29% growth rate estimate materialized, it would translate to a growth rate of about 8.3% 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 extensively but only appreciated 1.78% on the day.

Going forward, it’s reasonable to expect continued economic normalization and RBC’s earnings to normalize.

What should investors expect from RBC stock going forward?

As mentioned earlier, RBC stock’s payout ratio is at its historic low thanks to a resurgence in its earnings and a quarterly dividend that had stayed the same for six quarters so far. If you 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 could be in the 5-8% range.

RY stock is reasonably valued today. With a 6-8% growth rate and a 3.4% dividend, the safe bank stock can deliver long-term annualized returns of about 9-11% assuming no valuation expansion or compression.