Royal Bank (TSX:RY) is up 23% since late October in a rebound that caught many people by surprise. Investors who missed the rally are wondering if Royal Bank is still undervalued and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) focused on dividends and total returns.
Royal Bank share price
Royal Bank trades near $133.50 at the time of writing compared to about $108 four months ago. The stock was as high as $147 in early 2022 before the Bank of Canada and the U.S. Federal Reserve started raising interest rates.
Upward movements in interest rates are usually positive for banks as they enable the banks to generate better net interest margins. A steep increase in rates over a short period of time, however, puts businesses and households with too much debt in difficult situations. The decline in the share prices of Royal Bank and its peers through last fall occurred as markets began to worry that the central banks would have to keep rates high, even as they pushed the economy into a recession to get inflation under control. Economic downturns lead to job cuts, which puts more pressure on families already struggling with higher debt and living costs. Royal Bank increased provisions for credit losses (PCL) last year, and the trend is expected to continue in 2024.
The rally in the stock occurred as markets started to price in rate cuts for 2024. This is still the expectation, although there are risks that the central banks will hold rates higher for longer than is currently anticipated in the market.
As such, there is still some downside risk for Royal Bank and other banks.
Earnings
Despite the headwinds, Royal Bank remains a very profitable company. The bank generated fiscal 2023 adjusted net income of $16.1 billion, which was slightly above the 2022 results. Return on equity (ROE) was high at 15.4%, and Royal Bank finished the year with a common equity tier-one (CET1) ratio of 14.5%. This is well above the 11.5% required by regulators, although a good chunk of the excess capital will be used to complete the $13.5 billion takeover of HSBC Canada.
Dividends
Royal Bank has a strong track record of dividend growth. The board increased the distribution twice last year, so management can’t be too concerned about the profits outlook. Investors who buy the stock at the current price can get a 4.1% dividend yield.
Should you own RY stock now?
At 12.7 times trailing 12-month earnings, Royal Bank likely trades at a fair value today. Investors who already own the stock should probably continue to hold. New investors might want to take a half position and look to add on any further downside. Any indication that the central banks are going to hold rates high through to next year could trigger another pullback. However, it wouldn’t be a surprise to see markets push higher in the coming weeks.
Over the long haul, Royal Bank should deliver solid total returns. The stock isn’t cheap, but it still deserves to be on your radar at this level, and the dividend pays you well to ride out any additional turbulence.
