If you are looking for an undervalued high-yield stock, then look no further than Toronto-Dominion Bank (NYSE: TD), more commonly known as just TD Bank. It has a lofty 5.2% dividend yield, which is more than twice the 2.5% yield of the average bank stock.
There’s a reason TD Bank’s yield is so lofty right now. It just got hit with a big fine because its U.S. business’ money laundering oversight failed, and the stock is down. Needless to say, there’s a lot of headline risk right now. But this issue isn’t likely to be a long-term problem for the 169-year-old bank. In fact, this is quite possibly an ideal time to buy its undervalued stock. If you don’t, you might end up regretting it a few years from now.
TD Bank’s rock-solid foundation
TD Bank is the second-largest bank in Canada by deposits. This is important to the story because it provides the foundation for the company’s overall business. The Canadian banking sector is highly regulated. This has resulted in two key differences from the U.S. banking sector. First, the largest banks are basically protected from competition. Second, Canadian banks tend to be run conservatively.
Although TD Bank is currently dealing with headwinds, they are not coming from Canada. Its Canadian banking operation remains strong and resilient. So, TD Bank’s core operations aren’t a problem. Investors are more worried about its efforts to grow in the U.S. market, which have just been put on pause for a little while thanks to a regulatory decree. That’s unfortunate, but it is hardly the end of the world for a company that has paid a dividend every single year since 1857, its third year of operation.
TD Bank clearly knows how to roll with the punches, noting that the dividend got paid during the Great Depression and the Great Recession. In fact, during the 2007 to 2009 recession, TD Bank maintained its dividend even as some of the largest and most respected U.S. banks cut their dividends. But what are the problems TD Bank is dealing with that have Wall Street so down on the stock?
TD Bank messed up and it is fixing the problem
TD Bank’s internal controls around money laundering failed in the U.S. market. That’s not good, and it has resulted in a few material negatives. For starters, the bank was forced to call off a U.S. acquisition. It has also had to spend the time and resources necessary to upgrade its internal controls, which will result in ongoing higher costs in its U.S. business. And it just got hit with roughly $3 billion in fines. That hurt, with the company ending up selling a portion of its ownership stake in Charles Schwab to come up with the cash.
These are all largely events that are in the past at this point. The bigger problem is that U.S. regulators are going to formally scrutinize every move TD Bank makes for a little while. Just about anything it wants to do will need regulatory approval before it happens. And TD Bank has been put under what is often called an asset cap. Basically, the bank can’t increase its size in the U.S. market until it has regained the trust of banking regulators. In 2025, TD Bank is going to have to rework its U.S. banking business a little to make sure it can support its customers. This will require selling some securities it owns with low returns so it can free up capital, which will likely depress its U.S. earnings in the short term but actually strengthen the business over the long term.
However, the really big problem is that, until TD Bank has regained regulator trust, acquisition-led expansion is probably off the table in the United States. This is the big reason why investors are so downbeat on TD Bank. Thus, the company also needs to regain investor trust. But if you think in decades and not days, you can appreciate that TD Bank is likely to muddle through this rough patch in relative stride. And, once it has appeased regulators, U.S. growth will resume. Could it take a few years? Sure. But for a company that’s been around as long as TD Bank, a few years, even as long as a decade, isn’t really all that meaningful.
Take advantage of the dislocation
TD Bank messed up. Management knows it and has owned it. The problem will probably derail the bank’s growth plans for a while, which is clearly not a good thing. But Wall Street is treating TD Bank like a banking pariah even though this is likely to be a temporary setback for a company that remains very well run, overall. If you can stomach stepping in while others are scared, you’ll get paid very well via that well above-average 5.2% dividend yield while you wait for TD Bank to get back on the growth track. When it does, investors are probably going to reward it with a higher valuation again.
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Charles Schwab is an advertising partner of The Ascent, a Motley Fool company. Reuben Gregg Brewer has positions in Toronto-Dominion Bank. The Motley Fool recommends Charles Schwab. The Motley Fool has a disclosure policy.
A Few Years From Now, You’ll Wish You’d Bought This Undervalued Stock was originally published by The Motley Fool
