An exterior view of a TD Bank branch in downtown Calgary, on Feb. 12.Amir Salehi/The Globe and Mail
Toronto-Dominion Bank’s TD-T share price has gained 16 per cent over the past two months, making it by far the best-performing Canadian big bank stock over that period.
The rebound, which followed a demoralizing year for long-term investors, is not a big surprise, though, and supports an intriguing method for picking bank stocks.
Prior to the recent liftoff, TD had three things going for it.
For starters, the stock was beaten up and cheap, after floundering through much of 2024 because of a U.S. investigation into its flawed anti-money laundering practices.
In October, the investigation ended with bad news for shareholders. Regulators and the U.S. Department of Justice levied a US$3-billion fine on TD. Arguably more damaging, they also imposed a cap on its U.S. retail banking assets, limiting the bank’s growth in the United States for years.
By early December, the share price was nearing a four-year low and trailing all its peers for the year. At its low point, the stock was down more than 30 per cent from its recent high in 2022. The decline pushed the stock’s dividend yield above 5 per cent, which is unusually high for TD.
Using a popular valuation metric, TD’s shares traded at just nine times estimated earnings in December, according to data from National Bank of Canada analyst Gabriel Dechaine. That was the lowest price-to-earnings ratio among the Big Six banks and well below the sector average of 10.6.
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TD, which used to trade at a premium, thanks partly to strong growth within its U.S. footprint, was relegated to the bargain bin.
While this unusual status may have dismayed many investors worried about the bank’s thwarted U.S. prospects, the cheap valuation suggested low downside risk while raising the potential payoff should a rebound take hold at some point.
The second thing TD had going for it was a leadership shake-up.
In September, the bank announced that Raymond Chun would succeed Bharat Masrani as chief executive officer in 2025.
New leadership does not mean an end to TD’s significant challenges. But the change may have struck the right chord with investors: It signalled that TD was serious about bringing in a fresh approach.
Mr. Chun took the helm on Feb. 1, earlier than expected. This week, he made the investor-friendly – if not terribly surprising – decision to sell the bank’s entire stake in U.S.-based investment dealer Charles Schwab Corp.
The deal raised $20-billion, illustrating the tremendous financial flexibility that a banking giant like TD enjoys. Mr. Chun said the proceeds would be directed toward growth opportunities in Canada and share repurchases. Given that TD’s share price leapt 3.9 per cent on the news, investors appeared to applaud the move.
“It confirms that Raymond Chun, new CEO, is willing to act and act quickly to drive shareholder value,” said Paul Holden, an analyst at CIBC Capital Markets, in a note.
The third factor working in TD’s favour is the most appealing: The banking sector rewards laggards.
The sector is an oligopoly with six large players that dominate financial services. Competition is fierce, but not a lot distinguishes financial products, such as loans and mortgages, from one another.
As a result, bank stocks tend to revert to the mean over time, as underperformers outperform. This tendency is so reliable that it forms the basis of several exchange-traded funds.
One of them, the Hamilton Canadian Bank Mean Reversion Index ETF (ticker: HCA in Toronto), is now emphasizing TD in its holdings.
But even an equal-weighted bank ETF, which holds all six bank stocks in equal amounts, will buy laggards as the fund rebalances. Unwanted TD shares, then, would have been scooped up over the past few months.
The question now: Is TD still the Canadian bank stock to buy?
It remains a laggard. Over the past 52 weeks, the stock’s return is dead last among the Big Six, even with its recent rebound. Its return over this period trails the top performer, Canadian Imperial Bank of Commerce, by more than 37 percentage points.
The stock is still cheap too. The dividend yield is 4.9 per cent, which is higher than those of all peers except for Bank of Nova Scotia. And the still-low price-to-earnings ratio points to a 10-per-cent discount to the sector, according to Mr. Dechaine.
True, TD’s challenges in the United States aren’t going away. And the sale of Charles Schwab means the bank has lost an important profit engine. But as bank investors know, bad news can be good.