Numbers aside, both Royal Bank of Canada (TSE:RY) and Toronto-Dominion Bank (TSE:TD) investors need to watch the Financial Consumer Agency of Canada probe
Vasudha Sharma | April 11, 2017 | SmallCapPower: Canadian banks are considered the bellwethers of Canada’s economy. They have performed exceptionally well when compared to banks throughout the globe, standing upright even during the recession and the banking crises in the United States. So for investors, it’s always been a tough call to make when trying to pick a more promising investment bet from among Canada’s banking majors, especially the top two – the Royal Bank of Canada (TSX: RY) (NYSE: RY) and the Toronto-Dominion Bank (TSX: TD) (NYSE: TD). Let’s examine which of the two could be a better bet for investors right now.
RBC, Canada’s largest lender, reported a stellar first quarter this fiscal, clocking in a 24% jump in its net income that totaled over $3 billion. The growth was driven largely by its personal and commercial banking business. RBC’s booming wealth management arm and its capital markets division also pulled up its numbers. TD, in comparison, posted a lackluster 6% increase in its net income at $2.4 billion in Q1/2017. It did beat Street expectations, but the margin was clearly slim.
Another measure of profitability that investors need to focus on is how much return on equity (ROE) they can expect from these two stocks. For instance, in Q1/2017, RBC generated the second highest ROE in the Canadian banking pack at 16.7%. This is well above the sector average and a 120 basis point jump from Q4/2016, indicative of consistency. Compare this to TD, which stands second last among the ‘Big Five’ with a ROE of 12.76%. The higher the return on equity, the more money the bank is making. And clearly RBC is the more lucrative option here.
The other metric that income-seeking investors must assess banks on are their dividend yields. RBC has been consistent in doling out exciting dividends to its investors over the years. In Q1/2017, RBC hiked its payout by 5% to $0.87/share, the largest increase in two and a half years and a sign of the management’s confidence that growth at RBC will remain on an upswing. It should matter to investors that RBC boasts the highest rate of dividend growth over the last five years among Canada’s ‘Big Five’ banks.
At TD, the Q1/2017 dividend was increased by 9% to $0.60/share. This is TD’s seventh straight year of quarterly payouts and in terms of the dividend yield both banks are somewhat comparable. However when you do a deep dive and compare the dividend payout ratio, you spot a clear winner. RBC‘s payout ratio stands at 46% while TD’s is at 41%.
On the sidelines, RBC is also aggressively repurchasing its shares from the market. That means every investor gets to enjoy a bigger piece of the pie even as earnings per share get a bump up.
Credit quality is another crucial check for investors looking for returns from bank stocks. Going by its Q1/2017 results, analysts have inferred that RBC’s credit is in top shape, especially since it posted a significant decline in its exposure to bad loans in the energy sector. RBC’s liquidity measure, the CET1 also soared by 20 basis points, giving the lender more elbowroom to play with its capital. TD’s credit quality in comparison to RBC’s is not as spotless. TD increased its provisions for credit losses (PCL) in a stark contrast to its peers who across the board have lowered their cash stockpile for bad loans.
Investors would also find it useful to keep a track of the price-to-book ratio (P/B ratio) of the two stocks. It’s an intuitive measure of how much value the market places on a company during the good times and the bad. RBC’s P/B ratio of 2.2 versus TD’s 1.85 shows us the confidence the market places on the former. Perhaps that why, RBC’s premium valuation seems justified.
Numbers aside, in light of the recent allegations of illegal sales practices made against TD, Bank of Montreal and Bank of Nova Scotia, investors must keep a close watch on what eventually comes out of the probe that the Financial Consumer Agency of Canada has launched into the sector.
There is industry talk that any reputational damage to the TD brand would impact both its earnings and its premium valuation. Analysts are even accounting for a higher risk and have downgraded their rating on TD from ‘outperform’ to ‘sector perform’. Investors must factor in any possible fallout and make their moves accordingly.
Vasudha Sharma is a Business Journalist who has extensively reported on real estate, infrastructure and home finance for both Television and Digital platforms. She has interviewed business leaders, policymakers and industry experts about emerging economic trends as part of her experience as a Business News Anchor and Reporter.
Disclosure: Neither the author nor any of the principals at Small Cap Power, or their family members, own shares in any of the companies mentioned above.
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