Royal Bank (TSX:RY) and Bank of Montreal (TSX:BMO) are off their 2023 highs amid a broader pullback in the bank sector. Contrarian investors with a buy-and-hold strategy are wondering if one stock is now undervalued and good to buy for a self-directed portfolio.
Royal Bank is Canada’s largest financial institution with a current market capitalization near $170 billion. The stock currently trades close to $123 compared to almost $140 earlier this year.
Big banks should benefit when money moves out of smaller institutions during periods of fear, as we saw in recent months, when bank runs resulted in the demise of a few regional banks in the United States.
Royal Bank has a diversified revenue stream with strong operations across segments and geographies. The company has commercial and retail banking, wealth management, capital markets, investor and treasury services, and insurance divisions. Canada and the United States drive the bulk of the revenue, but Royal Bank operates in more than 30 countries.
Management has decided to use the excess cash built up during the pandemic to make two strategic acquisitions. Royal Bank acquired a wealth management business in the United Kingdom for about $2.4 billion last year. The company is also in the process of buying HSBC Canada in a $13.5 billion all-cash deal that will add about 130 branches and a portfolio of affluent clients.
Royal Bank raised provisions for credit losses when it reported fiscal second-quarter (Q2) 2023 results. As interest rates continue to increase more loan losses are expected at all the banks. Royal Bank still generated $3.8 billion in adjusted net income in the quarter and raised the quarterly dividend by about 2% to $1.35 per share. This suggests that management isn’t too concerned about the profit outlook over the next couple of years.
Investors who buy the stock can get a 4.4% dividend yield at the current share price.
Bank of Montreal
Bank of Montreal has a market capitalization of close to $84 billion at the time of writing. The stock trades below $118 per share compared to $136 in February.
Volatility in the American banking sector might be a reason BMO stock recently dipped to a 12-month low. The company closed its US$13.4 billion purchase of Bank of the West in early February. This was right before the meltdown in the share prices of American regional banks.
Bank of the West gets the majority of its deposits from clients in California. The demise of two major California-based banks, Silicon Valley Bank and First Republic, has likely impacted investor appetite for BMO’s stock. At the very least, investors might be concerned that Bank of Montreal paid too much to secure a solid footprint in the California market. The deal added more than 500 branches to BMO Harris Bank, the American subsidiary.
Over the long term, the deal should benefit investors. Bank of Montreal continues to maintain a strong capital position to ride out turbulence and the business actually delivered higher profits in fiscal Q2 2023 than it did in the same period last year. Adjusted net income came in at $2.2 billion, compared to $2.19 billion in fiscal Q2 2022.
The board increased the quarterly dividend by $0.04 per share to $1.47 when it announced the fiscal Q2 results. At the time of writing, the new distribution provides an annualized yield of 5%.
Is one a better bet?
Royal Bank and Bank of Montreal pay attractive dividends that should continue to grow. Investors seeking passive income might want to make Bank of Montreal the first pick for the higher yield. BMO is probably oversold at this point as well but could be more volatile if the bank sector in the U.S. gets chaotic again in the coming months.
Royal Bank should be a solid pick at the current price for investors who want a core anchor holding for their portfolios. I would probably split a new investment between the two stocks today.