Royal Bank of Canada: What Would Warren Do?

Before making any investment decision, I always find it helpful to consult the prophet of value investing, Warren Buffett. Unfortunately, the Oracle won’t take my calls yet, so I have to rely on his teachings for advice. Fortunately, he has been kind enough to share his thoughts with all of us. I urge all disciples of value investing to read and re-read his partnership letters and Berkshire Hathaway’s (BRK.A, BRK.B) annual reports.

I’ll save you the trouble of reading over 1,000 pages right now and preface my three major takeaways from Warren’s writing. First, recognize that to own a stock is to own a share in a business. Second, buy a quality business when it goes on sale. Third, as long as that business retains its competitive advantage, hold on indefinitely.

The other day, we debated selling our holdings of Royal Bank of Canada (RY.TO) for one of the cheaper Canadian Banks, Canadian Imperial Bank of Commerce (CM) or Bank of Montreal (BMO). Sure the thesis makes sense; Royal is being valued at 15% premium to CIBC and BMO and offers a smaller dividend. But I make sure to consult Warren on this one:

It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. -- Warren Buffett: Letter to shareholders, 1989.

There’s a reason that CIBC and BMO trade at a discount to Royal. BMO’s lack of revenue growth coupled with execution risk from a recent acquisition is a concern. CIBC has also had trouble growing its revenue base and is more leveraged to Canadian retail lending. Plus, CIBC still has exposure to potential risk from the bankruptcies of Lehman Brothers and Enron. Royal is more expensive on a relative basis, but that doesn’t mean I should trade in my Rolls Royce for a Toyota. Looking under the hood, we found that BMO and CIBC have always traded at a discount to Royal Bank and that neither of these companies is being valued at a huge discount to their historical trading multiples.

Royal Bank, which operates the largest Canadian banking franchise, trades at 11.8 times this year’s earnings, and offers a dividend of 4%. The bank is a wonderful company trading at a more than reasonable price, so I’m with Warren on this one. We’re holding on indefinitely.

Disclosure: Clients of Baskin Financial own shares in Royal Bank