It’s a common misconception that Toronto-Dominion Bank (TSX:TD)(NYSE:TD) an expensive stock because of its higher price-to-earnings multiple when compared to its peers in the Big Five. Toronto-Dominion Bank has always commanded a premium over its peers, and for good reason. The company has a fantastic risk-management strategy and a fast-growing U.S. banking segment, which will turn into a huge strength over the next few years as the U.S. Federal Reserve raises interest rates.
As the brilliant Warren Buffett once said, “Price is what you pay, value is what you get.” Although Toronto-Dominion Bank is higher than its peers, I believe the value is much greater because of huge tailwinds the company will ride in 2017 and beyond.
First, Toronto-Dominion Bank’s U.S. segment will be a huge strength this year due to rising interest rates and a pro-business U.S. president, Donald Trump. The loonie could also be decreasing into 60-cent territory this year, and Toronto-Dominion Bank offers a terrific hedge against this trend.
As of writing, the stock is currently trading in line with its historical average valuation, but it should actually be more expensive considering the huge catalysts that will boost earnings over the next few years. I believe that the valuation gap between Toronto-Dominion Bank and its peers in the Big Five will widen this year, as Toronto-Dominion outperforms thanks to its strong U.S. banking segment.
If you’re just comparing the current dividend yield to its historical average, then you’re not going to get far. The company is poised to increase its dividend by a larger amount than any of its peers over the next few years thanks to the catalysts which will improve the amount of free cash flow.
Although Toronto-Dominion Bank is the most expensive of the Big Five when looking at traditional valuation metrics, I believe the company is actually the most undervalued because of the short- and long-term tailwinds that will propel the stock higher.
The company is a dividend-growth king and is expected to accelerate dividend growth for the next few years as it enjoys a stronger U.S. economy.
The less-than-impressive fourth-quarter earnings report is your chance to jump into the stock before it takes off. The Canadian banking segment showed some weakness, but the U.S. segment was booming. Next year, it’s pretty much guaranteed that the U.S. segment will be even stronger as the terrific management team at Toronto-Dominion Bank works to strengthen its Canadian segment.
Toronto-Dominion Bank is the best bank of the Big Five and will have a fantastic 2017. You can’t just look at the dividend yield and the price-to-earnings multiple compared to the industry. You have to dig deeper and find out what catalysts will propel the stock higher in the future. You also need to figure out what is going to drive free cash flow such that the company can afford to increase its dividend by a significant amount for the next few years.
While comparing valuation metrics to historical averages offers some insight as to whether or not a stock is a good value, one must not ignore short- and long-term catalysts the stock will have going forward. You shouldn’t rely entirely on past data when determining whether a stock is expensive or not, because it’s where the company is going that you should be concerned about when looking for a stock to buy.
Stay smart. Stay Foolish.
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Fool contributor Joey Frenette has no position in any stocks mentioned.