Bank of Montreal (TSX: BMO) is up about 20% since late August. Investors who missed the bounce 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) focused on high-yield dividend stocks.
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Bank of Montreal stock
Bank of Montreal trades close to $132 per share at the time of writing. The stock is near its high point for 2024 but is still down from the $152 it reached in early 2022 before bank stocks started to pull back on fears that interest rate hikes would trigger a recession in Canada and the United States.
Bank of Montreal also came under pressure in the past year for its US$16.3 billion acquisition of Bank of the West, an American regional bank based in California. The deal was announced in late 2021 when bank stocks were near the top of their post-pandemic rally. Bank of Montreal closed the acquisition in early February 2023, just before regional bank stocks in the U.S. took a big hit as some high-profile bank failures shocked the market.
In hindsight, Bank of Montreal likely paid a heavy premium to secure Bank of the West. Over time, however, the deal should prove to be a win for investors. Bank of the West added roughly 1.8 million new customers and more than 500 branches to BMO Harris Bank, the American subsidiary. California is a large market in the United States, so the deal gives Bank of Montreal a solid platform to expand its American presence. The bank has a long history of making successful strategic acquisitions south of the border.
Risks
Bank of Montreal raised its provisions for credit losses (PCL) in recent quarters as more customers found themselves in a tight spot due to the surge in interest rates. Recent cuts to interest rates in both Canada and the United States should ease the pressure on struggling borrowers, but bond markets are signalling an expectation that rates will not fall as much or as quickly as previously expected.
Inflation in Canada jumped from 1.6% in September to 2% in October. In the United States, inflation came in at 2.6% in October. A tight labour market and ongoing economic strength in the U.S. could force the U.S. Federal Reserve to hit the brakes on rate cuts. In 2025, the Trump administration is expected to implement broad import tariffs. This could push inflation higher, forcing the central bank to keep rates where they are or even implement another rate hike. In that scenario, there could be more defaults, and PCL at Bank of Montreal might remain high or increase.
In Canada, the economy isn’t as strong as it is in the U.S., and unemployment has drifted higher. The Bank of Canada wants to cut rates to support the economy, but it can’t let the spread between Canadian and U.S. rates get too large due to the negative impact it could have on the currency. If the Canadian economy falters and unemployment jumps while interest rates are still high, the domestic banks could be in for a rough ride as millions of households with expiring fixed-rate mortgages secured at cheap rates during the pandemic are forced to renew at much higher rates over the next two years.
The bottom line
Bank of Montreal pays an attractive dividend that should continue to grow. Investors might want to consider a half position at the current price and look to add on any potential weakness. With a 4.7% yield, you get paid well to ride out a pullback if things get ugly next year. Over the long haul, BMO should be a solid dividend pick.
