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Canadian Value Stocks: How to Spot Undervalued Stocks PLUS! Our Top 4 Value Stocks

Topic: Value Stocks

Get a 4.9% yield from cheap Royal Bank of Canada shares

Royal Bank is celebrated as a conservative, blue-chip stock offering a dependable dividend yield.

But there’s more. It has also returned our investors a massive 1,430.9% gain since we first recommended it in April 1995. That gain dramatically outpaced the 354.3% rise for the S&P/TSX Composite index.

Why buy now? Current uncertainty caused by rising interest rates and still-high inflation has prompted Canada’s big banks to increase their loan-loss provisions.

The Profits from Hidden Value

Learn everything you need to know in 7 Pro Secrets to Value Investing for a FREE special report for you.

Canadian Value Stocks: How to Spot Undervalued Stocks PLUS! Our Top 4 Value Stocks

Those provisions remain well below their 2020 pandemic peaks. Still, the impact on earnings impacts valuations and that only increases the current buying opportunity.

 The stock trades at modest 10.0 times forecast earnings. That’s cheap for such a solid business.

ROYAL BANK OF CANADA (Toronto symbol RY; agreed in November 2022 to pay $13.5 billion in cash for the Canadian operations of U.K.-based HSBC Holdings plc (New York symbol HSBC). That includes 130 branches, which mainly cater to businesses in industries that trade and bank internationally. HSBC also provides banking and wealth management services to over 770,000 retail clients. In all, it has total assets of $134 billion.

Canada’s Competition Bureau recently approved the acquisition. The deal still needs other approvals, but Royal expects to complete the transaction in early 2024. The bank expects it will cost $1 billion to integrate the new operations, but also expects to realize annual cost savings of $740 million by the end of the second year.

The purchase will cut Royal’s capitalization ratio (CET1, or Common Equity Tier 1, a key measure of its ability to absorb bad loans) from 14.1% as of July 31, 2023, to around 11.7%. However, that is still well above the regulatory minimum of 11.0%.

The bank could sell more common shares to lift its CET1 ratio. If it does, the additional shares would have little dilutive effect on existing shareholders.

Due to the small size of the Canadian banking market, Royal prefers to expand internationally. For example, in 2015 it acquired Los Angeles-based City National Bank for $5.5 billion U.S. in cash and shares. City National lends to wealthy individuals as well as businesses in the entertainment, technology and health-care industries.

That acquisition is a big reason why overall revenue rose 20.5% for Royal, from $40.67 billion in 2017 to $48.99 billion in 2022 (fiscal years end October 31).

Overall earnings gained 12.5%, from $11.43 billion in 2017 to $12.86 billion in 2019; due to fewer shares outstanding, earnings per share rose at a faster rate of 15.7%, from $7.56 to $8.75.

Royal set aside $4.35 billion to cover potential loan defaults in fiscal 2020 due to the uncertainty over COVID-19; that was up 133.4% from $1.86 billion in 2019. As a result of the spike, earnings in 2020 fell 11.1% to $11.44 billion, while earnings per share declined 10.6% to $7.82.

However, Royal was reversing those provisions as the economy re-opened. As a result, earnings in 2021 jumped 40.3%, to $16.04 billion; per-share earnings rose 41.4% to $11.06. In fiscal 2022, earnings then dropped 1.5%, to $15.81 billion, or $11.06 a share (on fewer shares outstanding). The reduced profit reflected lower results in Capital Markets and Insurance, partially offset by higher earnings in Personal & Commercial Banking, Wealth Management, and Investor & Treasury Services. The current year also reflects lower releases of provisions on performing loans than a year ago.

Meanwhile, Canada’s largest bank by market capitalization continues to benefit from higher interest income on its loans due to higher interest rates. As well, it cut the number of full-time employees by 1% in the latest quarter, and it plans to further reduce headcount by 1% to 2% in the current quarter.

In its 2023 third quarter, ended July 31, 2023, Royal’s earnings before unusual items rose 11.4%, to $2.84 a share (or a total of $3.96 billion) from $2.55 a share (or $3.56 billion) a year earlier. That topped the consensus estimate of $2.71 a share.

Due to rising interest rates and the possibility of higher loan defaults, Royal set aside $616 million to cover future loan losses, up 81.2% from $340 million a year earlier.

Value Stocks: Both revenue and earnings are up in the latest quarter for Royal Bank

Earnings from Royal’s retail banking (54% of the total) rose 5.5% due to higher interest rates. As well, earnings at Royal’s capital markets business (23%) jumped 56.6% due to a lower tax rate and higher bond trading volumes. The Insurance division (6%) also reported 22.0% higher earnings due to an improvement in the value of its investment portfolio.

Those gains offset a 17.9% drop in earnings at wealth management (17%), due to higher loan-loss provisions and higher staffing costs.

Overall revenue rose 19.4%, to $14.49 billion from $12.13 billion. That also beat the $13.25 billion consensus forecast.

For all of fiscal 2023, Royal will probably earn $11.14 a share, and the stock trades at an attractive 10.0 times that forecast.

As well, with the August 2023 payment, the bank raised your quarterly dividend by 2.3%, to $1.35 a share from $1.32. The new annual rate of $5.40 yields a solid 4.9%.

Recommendation in The Successful Investor: Royal Bank of Canada is a buy.

We hope you benefited from this analysis of Royal Bank of Canada. The bank is just one of the top-performing stock picks of our Successful Investor newsletter.

Of course, not all our picks over the years have produced these kind of spectacular gains. Some, in fact, have led to losses. But all portfolios need superstar stocks like this to offset those inevitable losses.

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