In these uncertain times, we are asked over and over by our clients : "How can I invest in the stock market with less volatility and more predictability?" Our answer is: "By investing in Bond-Like Stocks."Bond-Like stocks aren't for everyone, but once you get to know them, you might find they are just what you have been looking for. In our last audio blog (see link) we introduced the concept of Bond-Like stocks. These are stocks that have very high financial strength and credit ratings, a dividend yield higher than that of a 10-Year US Treasury bond, and a history of raising their dividends.
Royal Bank of Canada (RY) probably fits these criteria as well as any stock I can think of. Here are the particulars for RY.
- RY is one of 5 AAA rated companies in the world.
- Its current dividend yield is 3.9%, much higher than the 2.8% yield on a 10-year T-bond.
- It has raised its dividend an average of 10% per annum over the last 10 years.
In addition, RY, along with all the other Canadian banks, largely escaped the subprime crisis as a result of its conservative lending practices.
A look at Royal Bank of Canada's most recent earnings report reveals some very interesting data points.
- Quarterly allowances for loan losses were 48% lower than a year ago.
- Shares outstanding were almost flat, very different from big US banks which increased shares by up to 35% to meet government mandated net capital requirements.
- Total loans grew modestly, again contrasting the shrinking loan balances at most US banks.
- Perhaps the most striking data point was RY's return on equity (ROE). ROE for its second quarter was near 17%, almost as high as its 10-year average and almost double that of the big US banks.
At the above right is our proprietary Dividend Valuation Mode for RY (click to enlarge). The model suggests that the company may be as much as 14% undervalued, based on the year-ahead dividend growth we project. As we have said before, the Dividend Valuation Model is based on historical relationships of price versus dividend growth and changes in interest rates. These relationships may not hold true into the future, but on a historical basis the model has been able to predict the annual movement in the price of the stock at near 90%.
We'll have more to say about Bond-Like stocks in the coming weeks. Next time we'll describe the hidden value of rising dividends.
Clients and principals of Donaldson Capital Management own RY. See the conditions for use of this blog site at the right.
5 comments:
From the perspective of being here in Canada, I can say that RY has a good reputation as a place to bank.
Canadian banks have had some challenges in figuring out where to grow next. Expansion into the U.S. has not worked out that well. RY, TD and BMO have tried to expand in the U.S. while BNS is expanding in Latin America and Asia.
Good to see your voice, Shawn. Hope all is going well for you.
In answer to a question about taxes. RY's dividend will be reduced by a foreign tax. That tax, however, is recoverable on a person's individual tax return. This is not the case for retirement accounts. In this case,even after the 15% tax, the yield is still much higher than on a 10 year US Treasury.
Thanks for the post, great info.
Greg - what are your thoughts on maintaining a position in a stock that has not continued to raise the dividend on an annual basis? Per the RY website, dividends for 2010 and 2009 were the same as in 2008, the last year the dividend was raised. This doesn't appear to fit the "rising dividend" criteria, despite being undervalued.
Are you deploying new capital/reinvesting in this stock just because it is undervalued? At what point would you sell if management doesn't raise the dividend?
Do you set a minimum growth rate or yield on cost expectation over a set period?
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