The big Canadian banks are cash-generating behemoths. Despite the cyclicality associated with the banking sector, the entrenched positions enjoyed by large TSX banks allow them to easily tide over economic shocks compared to their counterparts south of the border.
The diversified businesses of Canadian banks enable them to deliver excellent results while outpacing consensus estimates consistently. For instance, while several U.S. banks were forced to cut and even suspend dividends during the financial crash of 2008, Canadian banks were praised for their strong balance sheets, robust business strategies, and conservative lending practices.
Should you buy Canadian bank stocks right now?
In the last 20 months, central banks have raised interest rates multiple times to offset inflation and reduce the money supply in the economy. The rising cost of debt has resulted in a tepid lending environment for TSX banks. Moreover, higher loan payments will also drive delinquency rates northwards, resulting in a drawdown of share prices for TSX banks.
For instance, shares of Royal Bank of Canada (TSX:RY) and Toronto-Dominion Bank (TSX:TD) are trading 26% and 29% below all-time highs, respectively. But the pullback also offers investors an opportunity to buy the dip and benefit from outsized gains when market sentiment improves.
RBC is the largest company on the TSX in terms of market cap and has operations in North America, Europe, and Asia. TD is well diversified geographically, with a growing presence in the U.S.
In addition to their leadership position in Canada, the two banks also offer shareholders a tasty dividend yield. As share price and dividend yields are inversely related, the drawdown in valuations has increased the yield for RBC and TD to 4.9% and 5%, respectively.
A good way to determine the buying point for TSX bank stocks is to wait for their dividends to hit 5%. While the 5% may seem like an arbitrary number, it has generally represented a bottom in share prices for bank stocks.
The last time shares of the two banks dropped to a yield of 5% was during the COVID-19 pandemic. Prior to the pandemic, it was during the oil-inspired pullback in 2016. If you had brought shares of RBC and TD in early 2016, your returns would have more than doubled in the last seven years, easily outpacing the broader markets.
TD and RBC stocks remain good buys right now
In addition to the decline in share prices, banks can also offer higher yields by increasing their payouts. In the last 20 years, TD Bank has raised dividends by 10% annually, while this figure for RBC is also quite high at 9.3%, showcasing the resiliency of their balance sheet and cash flows.
Investors remain worried about a sluggish macro environment, which should drive earnings for bank stocks lower in the near term. Alternatively, you can buy quality high-dividend stocks at a massive discount and enjoy inflation-beating gains on the rebound.
TD Bank stock is priced at eight times forward earnings and trades at a discount of 20% to consensus price target estimates. Comparatively, RY stock is priced at 9.8 times forward earnings and trades at a discount of 25% to consensus price targets.
