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Royal Bank (TSX:RY) is now in positive territory for 2023 after surging more than 20% in the past eight weeks. Investors who missed the bounce are wondering if RY stock is still undervalued and good to buy for a self-directed Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA) focused on dividends and total returns.
RY stock price
Royal Bank trades near $133 per share at the time of writing. The stock was as high as $147 in January 2022 and dipped below $110 at the bottom of the 2023 rout.
The decline that occurred over most of the past two years is largely due to rising interest rates in Canada and the United States. Banks often benefit when rates go up as they can generate better net interest margins. However, the steep increase in interest rates by the Bank of Canada and the U.S. Federal Reserve over such a short period of time started to worry investors that the end result would be a nasty recession.
The central banks are trying to cool off the economy to get inflation under control and back down to the 2% target. Inflation was 3.1% in Canada in November compared to 6.8% in the same month last year, so progress has certainly been made, but getting from 3% to 2% might still take some time. Labour markets remain tight and consumers are still spending savings that were built up during the pandemic.
That being said, rate hikes take time to work their way through the economy. The full impact of the increases has yet to emerge and there are concerns that the central banks have actually been too aggressive. Royal Bank is already setting more cash aside to cover potential bad loans, but the provision is still very small compared to the overall loan book.
The rebound in bank stocks over the past two months is due to bargain hunters scooping up cheap shares in anticipation that the Bank of Canada and the U.S. Federal Reserve will start to cut rates next year and achieve the goal of delivering a soft landing for the economy.
Royal Bank earnings
Royal Bank reported fiscal 2023 adjusted earnings of $16.1 billion. This was slightly better than the results for 2022, even amid a slowing economy and challenging conditions in capital markets. Adjusted return on equity (ROE) slipped from 16.6% to 15.4%, but Royal Bank remains a very profitable firm.
The bank finished fiscal 2023 with a common equity tier one (CET1) ratio of 14.5%. This is above the 11.5% required by regulators and translates into billions of dollars in excess cash. The cushion means Royal Bank has lots of extra funds to ride out market turbulence. It is important to note, however, that a good chunk of the excess cash is earmarked to complete the planned $13.5 billion takeover of HSBC Canada.
Dividend
Royal Bank increased the dividend twice in 2023. This should be a signal to investors that the board isn’t too concerned about the profit outlook for fiscal 2024. At the current share price investors can get a 4.1% dividend yield from RY stock.
Should you buy now?
Royal Bank deserves to be an anchor pick in any buy-and-hold portfolio targeting dividends and total returns. The big rally over the past two months is a reminder of how quickly market sentiment can change and how difficult it is to try to time the highs and lows.
That being said, the stock is likely fully valued at this point. Moreover, there is a possibility that the market is getting ahead of itself on the timing of rate cuts. Inflation didn’t change in Canada between October and November, so there is a risk that the Bank of Canada will have to keep rates at current levels through most of next year. As more households and businesses face rising debt costs, provisions will rise and there could be another sharp pullback in the bank sector.
At this point, I would either take a half position and look to add on a dip, or simply stay on the sidelines until there is more clarity on the direction of rates next year.
There are other top TSX dividend stocks with higher yields and cheap share prices to consider right now.
