Bank of Montreal (TSX:BMO) is up about 20% from the 12-month low it hit last fall. Investors who missed the rebound are wondering if BMO stock is still undervalued and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) portfolio focused on dividends and total returns.
BMO share price
Bank of Montreal trades near $124 per share compared to $103 around the end of October 2023. Two years ago, the stock topped $150 during the post-crash rally, so there is decent upside potential for a continued recovery.
Most of the pain over can be pinned on rising interest rates and a subsequent surge in bond yields. The Bank of Canada and the U.S. Federal Reserve have increased interest rates in an effort to cool down the economy and bring the labour market back into balance. Higher borrowing expenses force households to reduce discretionary spending. As demand for goods and services declines, businesses hire fewer new employees or begin to reduce staff numbers. The result should be a slowdown in price growth for goods and services as deals become more common and employees have less leverage to demand higher salaries.
The risk for Bank of Montreal and its peers is that the economy could slip into a deep recession, and unemployment could surge if interest rates stay elevated for too long. Rate hikes take time to work their way through the economy, and it is difficult for the central banks to know when to start reducing rates to avoid an economic crash.
Bank of Montreal set aside $2.2 billion to cover potential loan losses in fiscal 2023 compared to $313 million in fiscal 2022. The uptick indicates that over-leveraged borrowers are struggling with the jump in rates. This trend is expected to continue in 2024, and while the amount sounds significant, it is still small relative to the overall loan portfolio of about $660 billion.
Bank of Montreal finished fiscal 2023 with a common equity tier-one (CET1) ratio of 12.5%. This is above the 11.5% required by the bank regulator, so the company has a solid capital cushion to ride out ongoing economic turbulence.
Economists broadly expect the economy to go through a short and mild recession as the central banks get inflation under control. If that scenario pans out, BMO stock is probably oversold right now.
Adjusted net income slipped to $8.7 billion in fiscal 2023 from $9 billion the previous year, but the bank remains very profitable and is positioned well in both Canada and the United States to benefit from long-term economic growth.
Dividends
Bank of Montreal has paid a dividend annually since 1829. The board raised the payout twice in 2023, so management can’t be too concerned about the profit outlook, even with the current economic headwinds. Investors who buy BMO stock at the current level can get a 4.9% dividend yield.
Time to buy BMO stock?
Bank of Montreal isn’t as cheap as it was a few months ago, but the stock still deserves to be on your radar today for a buy-and-hold TFSA or RRSP portfolio. The dividend should continue to grow at a steady pace, and you get paid well to wait for the next leg of the recovery. Ongoing volatility is expected, but dips would present a good opportunity to add to the position.
