You don’t need to be a spectacular investor to make good returns on your investment. A buy-and-hold strategy in one of Canada’s Big Five bank stocks would have done just fine, particularly when serving as a piece of a diversified portfolio. For example, a $5,000 investment in Bank of Montreal (TSX:BMO) stock since 2004 (with dividends reinvested) would be worth about $25,680 today based on a compound annual growth rate (CAGR) of about 8.7%.
Notably, the stock has been weighed down by higher uncertainty in the economy. Economists believe both Canada and the United States could experience a recession by next year due partly to the rapid increase of interest rates by the central banks to put inflation under control. This has driven higher interest expenses for commercial and personal loans. Consequently, there are higher loan-loss provisions, and the banks’ earnings are lowered.
So, don’t be surprised if bank shares stay out of favour for some time. However, shareholders get a reliable dividend income that will likely increase over time.
BMO’s recent results
BMO reported its fiscal second-quarter results on May 24. Its adjusted revenue rose 11% to $15,150 million. Net interest income rose 19% to $9,231 million, while non-interest revenue climbed 48% to $7,703 million.
However, loan loss provisions were $535 million (versus a release of $49 million of provisions in the prior fiscal year period), and non-interest expense jumped 19% to $8,903 million, which weighed on earnings. Consequently, adjusted net income fell 6% to $4,488 million, and adjusted earnings per share were $6.15, a drop of 14% year over year.
In the first half of the fiscal year, BMO’s adjusted return on equity was 13.0% versus 17.2% a year ago. At the end of the fiscal second quarter, its common equity tier-one ratio was 12.2% compared with 16.0% a year ago. So, the bank continues to make good returns for its investors and remains sufficiently capitalized.
BMO stock’s valuation
At $119.37 per share at writing, BMO stock trades at about 9.4 times adjusted earnings, which is a discount of about 15% from its long-term normal valuation. It could take three to five years for the reversion to the mean. Indeed, analysts are less bullish about the stock in the near term. Currently, the 12-month consensus price target represents a discount of about 9%. In other words, they believe the stock is fairly priced.
What if you invested $5,000 into BMO stock today?
A good portion of BMO stock’s returns come from its dividends. For example, its 10-year dividend-growth rate is 6.8%. At writing, it offers a solid dividend yield of 4.9%. Its payout ratio is estimated to be sustainable at roughly 47% of adjusted earnings this year. Furthermore, it has a treasure chest of retained earnings that could help serve as a cushion for its dividend if needed. And the company’s earnings are anticipated to persistently grow for the long haul.
BMO could grow its earnings per share at a CAGR of about 6% over the next five years, which implies a five-year price target of $175.86. Combined with its dividend yield at writing, it suggests an estimated total return of approximately 13%, which would be pretty outstanding.
