Royal Bank of Canada: Is This 4.26% Yield a Buy?

Royal Bank of Canada (TSX:RY) stock has a 4.3% dividend yield, but is it a buy?

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Royal Bank of Canada (TSX:RY) stock had a 4.26% dividend yield at the time of this writing. This figure comes from $5.28 in annual dividends per share and a $123.89 stock price. The TSX stock market currently has a 3% weighted average yield, using last year’s dividends. So, RY stock has an above-average yield.

Is the stock actually worth buying, though?

As we saw this spring that banks can and do fail. The U.S. banks Silicon Valley Bank and First Republic Bank failed after their depositors rushed to withdraw funds. Canadian banks are more tightly regulated than U.S. banks, so the risk is a bit less when investing in Canadian financials. Still, bank stocks are not the kinds of equities you can just sleep on — you need to monitor their liquidity and deposit growth. In this article, I will explore some factors you need to know about in order to determine whether RBC stock is a buy today.

RBC stock: Risk management

Like most banks, Royal Bank of Canada has to invest significant amounts of time and energy into risk management. It’s vital because banks have a lot of liabilities — specifically deposits. Banks need enough liquidity to cover the withdrawals that are likely to occur. If they don’t, they can fail.

How is Royal Bank of Canada doing in terms of liquidity?

According to RBC, the bank has a 130% liquidity coverage ratio, meaning that it can cover 130% of expected withdrawals using its cash and short-term investments. This suggests a high level of liquidity. The bank also has a 12.1% common equity tier-one (CET1) ratio, which is high, and above the regulatory requirement. Technically, the CET1 ratio is a capital metric rather than a liquidity metric, but it’s related in that part of a bank’s capital is liquid assets.

Dividend sustainability

Having looked at RBC’s risk management, it’s now time to turn to its dividend sustainability. Royal Bank of Canada’s payout ratio is 46.7%, which is not high by the standards of all sectors, but is fairly high for a bank. Banks tend to reinvest their cash inflows into making more loans, so you don’t get the high payout ratios with banks that you find with real estate investment trusts. So, Royal Bank of Canada’s dividend looks fairly sustainable.

Dividend-growth potential

Last but not least, we need to look at Royal Bank of Canada’s dividend-growth potential. Having a high yield today is great, but what’s really nice is having a dividend that grows over time. With growing dividends, you can get truly phenomenal total returns.

Over the last five years, RY has grown its revenue by 4.99% per year and its earnings by 5.3% per year. If the company can keep this up into the future, then it will be able to increase its dividend. As for whether this will actually occur, that remains to be seen.

Verdict: Royal Bank of Canada is a good dividend stock

On the whole, I think that Royal Bank of Canada is a pretty good dividend stock. It has a high yield, its payout ratio is reasonable, and it even has a bit of earnings growth. The future may not resemble the recent past, but with its strong risk-management practices, RBC stock should do at least average.

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 Andrew Button has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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