Canada has recently been lavished with praise because of the strength of their financial institutions amid all of the global financial turmoil. Despite this halo effect, these banks have had their challenges. Royal Bank of Canada (RY) just took a large write down on their US assets. That may be a bell weather for other institutions such as Toronto Dominion (TD) and Bank of Montreal BMO), who also have large assets in the US.
I can’t help but thinking that Canadian banks are not looking attractive right now as investments whatsoever. With headwinds of further write-downs, low consumer confidence, increasing unemployment, increasing loan losses, and Canadian real estate value declines, the big 5 Canadian lenders share prices look downright frothy. This is quite a change from a few months ago when you could have bought some of the banks at decade lows and towering yields.
Let’s look at Royal Bank of Canada (RY) as an example for the group:
How quickly things can change. Royal Bank was trading at $26 in late February and is now changing hands at $43. That means that the stock was yielding 7.7% back in February and is now paying out more like 4.7% of their share price in dividends. That is dramatic rise in share price of 65%!
The P/E ratio is now 13.4x for a company that just took a $850M write-down and is facing multitude of pressure brought about by a recession. There is very little probability of any dividend growth in the short term so investors don’t have much to look forward to in the next two years in that arena. When Royal yields north of 7%, I would argue that as long as they don’t cut their dividend, buying might be wise; however 4.7% does not carry the same appeal.
You could look at all five banks and probably see a similar pattern. The rally in these banks recently looks overdone to me and I believe the expectation currently built up in their share prices is not realistic. The risk return on these investments is not attractive at the current level because the potential short to mid term return has probably evaporated and the risk still exists.