Buy Canada’s 2 largest banks for growth and income

Canada’s two largest banks have been in business since before the 1867 birth of the now-150-year-old country that we celebrate this weekend. Royal Bank was founded in Halifax in 1864; the Bank of Toronto (later merged with The Dominion Bank) was founded in 1855. Their shares may have slipped a bit recently, but both are financial stocks to buy for growth and income.

Bank_of_Toronto_1868Canada’s big five banks’ shares have retreated from their highs, largely due to concerns about the housing bubble. But since their mid-May lows, the shares have partially recovered. Despite the concerns, we believe Canada’s major banks are true blue chip stocks with the financial strength to withstand a real estate correction.

Royal Bank of Canada (TSX—RY; NYSE—RY) is Canada’s largest bank by market capitalization and one of North America’s leading diversified financial services stocks. The bank provides personal and commercial banking, wealth management, insurance, investor services and capital markets products and services on a global basis.

The bank’s first-quarter results were favourable. For the three months ended January 31, 2017, Royal made $2.8 billion (adjusted), or $1.83 a diluted share, compared to $2.4 billion, or $1.58 a share, in the same period of 2016. The results reflected strong earnings in personal and commercial banking, wealth management, capital markets and investor and treasury services.

The bank’s capital position is strong, with a common equity Tier 1 ratio of 11.0 per cent, up from 9.9 per cent a year ago. A high ratio gives the bank the flexibility to redeploy or return capital to shareholders. It has done the latter, recently increasing its quarterly dividend $0.04, to $0.87 a share.

While a real estate correction would undoubtedly result in a slowdown in lending activity that would hurt Royal’s bottom line, the bank’s healthy leverage and liquidity ratios position it to withstand a downturn and thrive over the longer term.

Royal Bank trades around a reasonable 12.8 times the $7.35 a share the bank is forecast to earn this fiscal year (ends October 31). The current annual dividend of $3.48 a share yields about 3.7 per cent.

Royal Bank is a buy for growth and income.

TD plagued by sales-target practices

Like Royal Bank, Toronto-Dominion Bank’s shares (TSX—TD; NYSE—TD) are off their recent highs, largely because of housing-bubble fears. But the bank has had an additional problem that surfaced in early March, when TD employees went public about their fears of being fired if they didn’t meet sales targets. Consequently, some of them admitted to breaking the law to meet targets. The bank has since launched a review of its sales practices.

TD is Canada’s second-largest bank by market capitalization and the sixth-largest in North America by branches. The bank serves customers in three key businesses that operate in a number of locations around the globe: Canadian retail, including TD Canada Trust; US retail, including TD Bank; and wholesale banking, including TD Securities.

The bank’s first-quarter financial results were favourable. For the three months ended Jan. 31, 2017, TD made $2.6 billion (adjusted), or $1.33 a diluted share, compared with $2.2 billion, or $1.18 a share, in 2016. The bank benefitted from strong results in its retail and wholesale segments on both sides of the border. Canadian retail net income rose four per cent to $1.6 billion, while US retail income increased seven per cent to $800 million.

TD bank also announced a $0.05-a-share increase in its quarterly dividend, to $0.60. At the same time, it declared its intention to buy back up to 15 million common shares, which will boost earnings per share.

We view the employee revelations about sales practices at TD as a temporary blow to its reputation. It’s likely the bank will eventually get past these difficulties with little effect on its long-term growth potential. And like RBC, we think the bank is positioned to withstand a sharp housing downturn, though such an event could have a considerably negative impact on its share price. It’s one of the risks you have to bear in mind when investing in Canadian bank stocks these days.

TD’s shares trade around 12.2 times this fiscal year’s (end October 31) forecast earnings of $5.24 a share. The current annual dividend of $2.40 a share yields 3.7 per cent. Toronto-Dominion Bank is a buy for growth and income.

This is an edited version of an article that was originally published for subscribers in the June 2017/First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.

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