Last week, I discussed why the buy-and-hold approach is the best strategy for most investors. Today, I’ll provide a real-life example to illustrate my point.
The stock I’ll be discussing is Royal Bank of Canada RY-T. I chose Royal Bank because it’s Canada’s largest company by market value, and I didn’t want people to think I was cherry-picking some obscure business with fabulous returns just to prove my point.
The purpose of this exercise is to demonstrate that, when you own an excellent company, you are much better off holding the shares through thick and thin than trying to trade your way through the market’s gyrations. I don’t know anyone who can do that reliably, but I know plenty of people who try.
So let’s imagine you had $10,000 to invest on Sept. 21, 2002 – roughly 20 years ago. You had read that Royal Bank had paid dividends every year since 1870, so it sounded like a pretty safe bet. You also had the foresight to enroll your shares in the bank’s dividend reinvestment plan (DRIP) to get the full benefit of compound growth.
Then you crossed your fingers and hoped for the best.
For the first five years, you felt like a genius. By Sept. 21, 2007, Royal Bank’s share price soared 114 per cent. Including reinvested dividends, your $10,000 had grown to $24,937, for a total return of nearly 150 per cent. Easy peasy, right?
But then the financial crisis reared its head. As hedge funds blew up and the U.S. housing market unravelled, banks around the world scrambled to shore up their balance sheets. Over the next 17 months, Royal Bank’s stock plunged by more than half. Adding to your misery, the bank went nearly four years without increasing its dividend.
But being a good buy-and-hold dividend investor, you hung in there. As Royal Bank’s stock price languished, you comforted yourself with the knowledge that, thanks to your DRIP, you were acquiring additional shares at low prices.
Staying the course turned out to be the right move. As the global economy recovered, Royal Bank’s stock went on to produce several years of impressive gains. By 2011, the bank was raising its dividend again.
If you’d sold your shares during the 2008-09 meltdown, you would have been kicking yourself.
But there was another global crisis ahead. In 2020, the COVID-19 pandemic sent markets tumbling around the world. Once again, Royal Bank’s stock plunged, and Canadian banks put dividend increases on hold, this time under orders from the Office of the Superintendent of Financial Institutions.
But, just as it had done after the financial crisis, Royal Bank’s stock eventually recovered from the pandemic-induced setback and went on to reach new highs. When OSFI gave the green light to resume dividend increases last fall, Royal Bank obliged with an 11.1-per-cent hike in December, followed by a 6.7-per-cent dividend boost in May.
I mentioned the financial crisis and the pandemic for a reason. Both were highly unusual events that created massive disruptions to the global economy. Yet, in both cases, Royal Bank not only survived, but thrived. So did Canada’s other big banks, and plenty of other companies.
Now for the big question: What would your reward have been for buying and holding Royal Bank shares through a 20-year period that included two of the biggest crises in recent memory?
Well, Royal Bank’s total return over that time, including dividends, was 12.45 per cent on an annualized basis. To put that into dollars, your initial $10,000 investment would have grown to $104,618 – a gain of 946 per cent – before tax.
Not bad for doing nothing but buying and holding. Remember, that’s without contributing any additional cash along the way, apart from automatically reinvesting your dividends.
Well, that’s great, you say. But what about the next 20 years? Nobody knows what will happen, of course. An asteroid could strike the Earth. Climate change could render large swaths of the planet uninhabitable. A third world war could break out. But barring a global catastrophe of unprecedented scale, I expect that Royal Bank and its competitors will continue to do what they do best: make billions in profits each year and pay rising dividends to their shareholders.
As for the near-term risks, one concern is that central bank rate hikes to cool inflation could trigger a recession. Fears of an economic slowdown are one reason bank stocks have fallen across the board recently. But Canadian banks have extremely strong balance sheets to weather whatever is coming. What’s more, as a group, they are trading at very attractive valuations that average less than 10 times estimated fiscal 2023 earnings. Royal Bank’s P/E is currently about 10.4, implying that investors expect above-average earnings growth relative to peers.
As Royal Bank’s return history illustrates, you don’t need to trade your way to wealth. The simplest, and most effective, way to build your nest egg is to buy great companies and hold them through good times and bad.
E-mail your questions to firstname.lastname@example.org. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
Special to The Globe and Mail