Royal Bank of Canada (TSX:RY) is Canada’s biggest bank by market cap. Boasting $14 billion in annual earnings, $1.9 trillion in assets and $1.2 trillion in deposits, it’s a true giant. The stock has performed pretty well historically, having made a 109% gain over the last 10 years while paying dividends all along the way.
So, history would tend to argue that Royal Bank of Canada stock is a good buy. However, there is much more to investing than past history. Sometimes long-term trends reverse, and sometimes good companies lose their touch. In order to know whether Royal Bank of Canada stock will remain a good value in the future, we need to know what kind of shape the company is in today.
That’s a tricky subject. Presently Canada’s yield curve is inverted, meaning that short-term bonds have higher yields than long-term bonds. Yield curve inversion tends to cause problems for Canadian banks, because they borrow on the short end of the curve and lend on the long end. There could be problems for Royal Bank here. So, let’s take a look at how the company is doing this year.
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Recent earnings
In its most recent quarter, Royal Bank of Canada beat on revenue but missed on earnings, boasting the following metrics:
- $13.6 billion in revenue, up 20%.
- $3.6 billion in net income, down 14%.
- A 14.9% return on equity, down from 18.6%.
- $2.58 in diluted earnings per share (“EPS”), down 13%.
- $600 million in provisions for credit losses (PCLs), up from a $358 million reduction in the allowance for credit losses last year.
The point about PCLs merits some explanation. The “allowance for credit losses” is the money banks set aside to cover loans that default. PCLs are additions to this sum. When a bank raises its PCLs, that means that it thinks the economy or its clients are getting riskier. So, Royal Bank sees potential defaults on the horizon.
The increase in PCLs was the main reason why Royal Bank’s earnings went down last quarter. The revenue growth (20% year over year) was quite strong, but when PCLs are added, they take a bite out of net income. That happened with Royal Bank last quarter. So, while net income declined on paper, the company’s revenue performance was very strong.
Valuation
Now we can get into Royal Bank’s valuation, a factor that is somewhat less flattering to it than its earnings performance is. Based on today’s stock price, Royal Bank trades at:
- 11.9 times adjusted earnings.
- 12.9 times GAAP earnings.
- 3.5 times sales.
- 4.5 times operating cash flow.
Apart from the operating cash flow multiple, these ratios are fairly high for a bank. Banks don’t usually reach high multiples because they typically don’t grow quickly, and face many risk factors. So while RY’s P/E ratio isn’t high compared to the S&P 500, it is high by the standards of the banking sector.
The bottom line
Taking everything into account, the Royal Bank of Canada looks like a pretty good bank stock. Stable, growing and boasting many liquid assets, it’s a stable 4% yield dividend stock that investors can count on.
