Royal Bank of Canada (TSX: RY) and Toronto-Dominion Bank (TSX: TD) are behemoths in the Canadian stock market. They have a combined market cap of $670 billion ($394 billion for RBC and $275 billion for TD). These two stocks alone collectively make up 10% of the TSX Composite Index. When they move, the index follows.
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Royal Bank and TD have delivered strong gains, but valuations are stretched
While Royal Bank and TD Bank are up 22% and 30% respectively this year, they have recently hit a pullback. Despite, investors should be cautious buying the stocks here. Both banks are trading with a price-to-earnings (P/E) ratio of 18. That is substantially above their long-term P/E average of 13.
No doubt, both these banks are considerably better than they were even 10 years ago. Generally, they have been great long-term investments.
Yet, these stocks are still economically sensitive and highly correlated to macro-economic factors. Rising bond rates, inflation, a stagnant economy, a challenging trade environment, and the potential for rising interest rates could all effect their future earnings.
You might not want to own these stocks at a peak valuation, especially when earnings growth is a little less than certain. You just don’t have a large margin of safety when buying them today. Also their dividend yields have compressed, so your return profile is a diminished.
Pembina Pipeline: A top Canadian infrastructure stock
If you are looking for a higher dividend yield than Royal Bank or TD, infrastructure stocks are an interesting place to look. Pembina Pipeline (TSX: PPL) stock is yielding 4.5% today.
With a market cap of $38.5 billion, it is one of the largest diversified energy infrastructure companies in Western Canada. As it adds LNG export terminals and data centre power assets, it is becoming more and more diversified.
89% of Pembina’s income is contracted. With a payout ratio of only 57%, the company still generates excess cash after it pays its dividend. That enables Pembina to maintain a strong balance sheet, grow its asset portfolio, and regularly increase its dividend.
Pembina is looking to grow its fee-based revenues by a 5-7% compounded annual growth rate over the coming four years. The company could do even better if energy prices remain elevated. This dividend stock offers a great mix of growth and income. You can buy Pembina today close to its long-term average valuation range.
Richards Group: A turnaround stock with a nice dividend
If you are looking for a really cheap stock compared to Royal Bank or TD, Richards Group (TSX: RIC) could be an interesting buy. This $328 million company only trades with a forward P/E ratio of 10! It also happens to have 4.3% dividend yield that is paid out on a monthly basis.
Richards has been a transformation in the works. The company has historically been a packaging distributor. However, it has been expanding into medical devices and medical disposables. Not only are these more economically resilient, but also higher margin.
Richards has been challenged due to tariffs and trade wars. However, with a greater focus on Canada and international opportunities, Richards is taking the right steps to diversify its distribution strategy.
This is a turnaround story, so a new investor might need to be extra patient. However, unlike Royal Bank and TD, this stock is cheap. If Richards can hit its stride through smart acquisitions and organic growth, there could be upside from earnings growth and a valuation re-rating.
