In a recent column, you mentioned that Royal Bank stock has produced an annualized total return (including dividends) of nearly 14 per cent over the past 20 years, which is very good. Do you think such returns will continue over the next 10 or 20 years or do you expect that growth for Royal Bank – and Canadian banks in general – will slow?
Royal Bank of Canada (RY) was the top performer of the Big Five Canadian banks over the past two decades, but the others weren’t far behind. For the 20 years ended Dec. 31, Bank of Nova Scotia (BNS) returned 12.1 per cent annually, Bank of Montreal (BMO) 11.7 per cent, Toronto-Dominion Bank (TD) 10.5 per cent and Canadian Imperial Bank of Commerce (CM) 10.4 per cent. Canada’s sixth-largest bank, National Bank (NA), topped them all, with a return of 15.2 per cent.
Will the next 20 years be just as prosperous? It’s impossible to say, as bank earnings and stock prices are affected by a multitude of factors including economic growth, the housing market, interest rates, loan losses and new forms of competition. But betting against the banks would be a mistake in my view; they are among the most powerful institutions in the country, with operations that span lending, wealth management, investment banking and insurance. They also pay attractive yields – currently averaging about 4.5 per cent – and during times of economic prosperity they raise their dividends regularly.
But our banks aren’t bulletproof. In 2019, bank earnings growth slowed dramatically following strong gains in 2017 and 2018. The slowdown reflected a sharp increase in loan-loss provisions, lower net interest margins (essentially the difference between what banks earn on loans and what they pay out to depositors and other lenders), restructuring charges and weaker capital-markets revenue.
But for long-term investors, Canadian banks are still very attractive, analysts say.
“Despite the mediocre earnings growth from the big six Canadian banks [in 2019], as well as the ominous macroeconomic environment, we continue to see their stocks as compelling long-term investments,” Odlum Brown analyst Benjamin Sinclair said in a recent note.
“Without exception, they each benefit from a stable, profitable banking environment in Canada, and they all have promising growth opportunities in other countries,” he said. What’s more, their price-to-earnings multiples have fallen recently “and are very low relative to their medium-term growth objectives.”
Odlum Brown has buy ratings on Royal Bank, TD Bank, Scotiabank and Bank of Montreal, citing their relatively stronger growth potential outside Canada.
Rather than pick one or two banks that you hope will outperform, consider diversifying across the sector to control your risk. You can accomplish this by buying a basket of individual bank stocks or by investing in a sector exchange-traded fund such as the BMO Equal Weight Banks Index ETF (ZEB) or the iShares S&P/TSX Capped Financials Index ETF (XFN). ZEB and XFN have similar management-expense ratios of 0.62 per cent and 0.61 per cent, respectively, but ZEB is a pure-play bank ETF while XFN also provides exposure to insurance, wealth management and diversified financials.
Keep in mind that, if you own a broad Canadian index ETF or mutual fund, you’re already getting a generous serving of Canadian banks. The iShares S&P/TSX 60 Index ETF (XIU), for instance, has roughly a 25-per-cent weighting in the Big Five.
Canadians love their bank stocks. I’ve even heard from readers who have 100 per cent of their portfolio in banks. It’s worked out well over the past few decades, but I still wouldn’t recommend it. In a severe recession, bank stocks could get clobbered. In my own portfolio, I keep my bank weighting to less than 20 per cent and supplement it with other dividend growers including utilities, power producers, consumer stocks and real estate investment trusts. By all means invest in our wonderful banks, but don’t go overboard.
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