This is the second of six dividend stock analyses I am conducting for Canadian bank stocks I already own or am considering for future investments. Several of the Canadian banks are classic dividend growth stocks, with a long history of stable and predictable earnings and dividend increases. Although all of the banks fall within a fairly narrow range of dividend yields, payout ratios and valuation metrics, subtle differences in these factors, and more significant differences in earnings and dividend growth rates, can translate into significant differences in total returns for long-term investors. You can see my analysis of Bank of Nova Scotia here.
The Bank of Montreal (NYSE:BMO) was founded in 1817 and has paid uninterrupted dividends since 1829. It is the fourth largest bank in Canada by market capitalization. The Bank offers diverse financial services to individuals and businesses including deposit and investment services, mortgages, consumer credit, loans, credit cards, financial planning, insurance, and other banking services. The company operates in 4 operating groups: Canadian banking (38% of latest quarter revenue), wealth management (22%), capital markets (22%) and U.S. banking (18%). The majority of BMO operations are in North America with less than 4% of revenue derived from foreign operations. The Bank is interlisted on the TSX and NYSE under the symbol BMO.
Revenue, Earnings and Dividend History
When evaluating dividend growth stocks I subscribe to the principle that dividend growth is a function of earnings growth and that earnings growth is a function of revenue growth. I like to see a long history of increases in each of these values over time. I also like to see how the company performs through at least one business cycle or sector downturn. I am not particularly concerned about declines in revenues and earnings for 1-2 year periods, so long as the trend is clearing rising over time and can recover its trajectory after a downturn. Likewise, I am not too concerned about a company missing the odd annual dividend increase when times are tough. However, a dividend cut is a big red flag. Good dividend growth companies should be able to maintain their dividend through business downturns.
BMO claims to be the longest running dividend paying company in Canada and has paid dividends annually since 1829. Despite its longevity, BMO has a reputation for being one of the slowest growing Canadian banks and traditionally trades at lower valuations and has higher yields than most of its counterparts. Over the last decade revenues, earnings and dividends have all increased between 3-6% (Compound Annual Growth Rate (OTCPK:CAGR)).
Note: All figures and calculations are in CAD$ unless otherwise stated.
BMO's growth rates are lower than I generally like to see for dividend growth stocks and they are lower than most of the other Canadian banks. Also, the growth rates have been less consistent than I like to see (see figure below), with flat revenues during the periods 2005-2010 and 2013-current, and a flat dividend rate for almost 5 years during 2008-2012. The higher growth of dividends over earnings is reflected in the expansion of the payout ratio from 36% to 45%.
Although the Canadian banks came through the financial crisis of 2008-09 relatively well compared to many American and foreign institutions (largely due to Canadian government regulations that limited the banks' exposure to sub-prime mortgage backed securities, collateralized debt obligations, and associated derivatives), BMO was harder hit than most of the other Canadian banks. This is reflected in a 5-year period of earnings recovery, a 4.5 year dividend freeze and a 62% decline in stock price at the peak of the financial crisis.
I estimated total returns for BMO over the last 10 years using year-end data and reinvesting dividends once per year at the end of each year. Using this approach a $10,000 investment at the beginning of 2005 would now be worth $22,488 (CAGR = 8.4%) and have a yield-on-cost of 8.0%.
Source: Created by author using data from Vectorvest
Using USD prices with dividends re-invested quarterly, a chart from buyupside.com indicates the yield-on-cost for an investment in 2005 would be just over 8%:
Earnings and Dividend Forecasts
The current dividend payout ratio is 45%, which is in the middle of the Bank's stated target range of 40-50%. Therefore, future dividend increases are likely to be in line with future earnings growth.
Analysts estimate the future 5 year earnings growth for BMO will be 9.5%, which is the same as the previous 5 years.
To forecast the potential return of BMO over the next 10 years I used an earnings growth rate of 6.5%, which is the average of the 3.6% historic 10-year rate and the 9.5% future 5-year estimate. For the dividend growth rate I also used 6.5% because that maintains the current payout ratio, which is in the middle of the Bank's stated target range. Using these assumptions, an investment of $10,000 would grow to $26,324 (CAGR=10.2%) and generate a yield on cost of 8.8% after 10 years.
Source: Created by author using data from Vectorvest
Obviously, historic performance and future estimates are no guarantee of actual returns. However, I believe forecasting exercises are useful because 1) they focus me to critically assess growth predictions/assumptions and 2) I find potential returns to be one useful factor to compare stocks with different dividend and growth profiles. Total return estimates can be especially useful for dividend growth stocks, where the returns are a combination of dividends and capital appreciation, and the total returns are less transparent than the returns from growth stocks or fixed income investments.
Timing and Valuation
BMO's recent price of $80 is currently 6% off its all-time high of $85 in mid-September. The bank just reported 4th quarter earnings on December 2 of C$1.63 a share, which were 5 cents shy of analyst's estimates. The earnings miss was largely due to a slump in capital market earnings that countered profit gains in personal and commercial lending in Canada and the U.S.
I typically do not use absolute valuation targets (e.g. a PE ratio<20) to assess stocks because the appropriate benchmark to use varies across sectors, stocks within sectors, and relative to current broad market valuations. Instead, I focus on comparing the current price of a stock relative to historic valuation metrics and invest at or below average valuations.
The following table shows the historic price valuation for BMO relative to past earnings and dividend multiples, and provides an estimated current share value based on the historic multiples. BMO has maintained a PE ratio in the range of 9-14 over the last 10 years, except during the financial crisis when the PE dropped as low as 6. The price:dividend ratio has ranged between 20-34, except for a low of 10 during the financial crisis. BMO's recent price of $80 is approximately 5% above historic earnings and dividend multiples.
Although BMO has produced an acceptable 10 year CAGR of 8.4%, the patterns of its earnings and dividend growth have been less consistent than some of its counterparts, like Bank of Nova Scotia. BMO's historic and future earnings growth are also lower than other Canadian banks. BMO has lower exposure to foreign markets than some of the other Canadian banks, which reduces its growth prospects and diversification, but its concentration in the North American market may provide lower volatility. Currently, BMO has reasonable valuation metrics with a PE of 11.8, a relatively high dividend yield of 3.7%, and a moderate payout ratio of 0.45. However, recent stock prices are about 5% above historic price:earnings and price:dividend multiples. Based on these factors I believe BMO is an acceptable stock to hold in a diversified dividend growth portfolio, but I prefer Bank of Nova Scotia and some of the other Canadian banks at current valuations. Look for my analyses of Royal Bank, CIBC, TD Bank, and Canadian Western Bank in the near future for comparisons.
Disclosure: The author is long BMO.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.