Toronto-Dominion Bank (TSX:TD)(NYSE:TD) has historically traded at a premium to its peers in the Big Six, and for good reason. The company has a very high-quality earnings stream, an impressive U.S. business, and a management team that knows how to manage risk incredibly well.
I believe TD Bank deserves to trade at such a premium relative to its peers, but recently, the valuation gap has shrunk thanks to short-term reasons which have no long-term fundamental impacts on the business itself. Since TD Bank is arguably one of Canada’s best banks, shares rarely ever trade at levels where its price-to-earnings multiple is below a majority of its Big Six peers. For that reason, the general public may rarely ever consider TD Bank “cheap.”
It’s common practice to compare price-to-earnings multiples of stocks in the same industry to determine whether or not shares are good value at a specific point in time. Comparing a stock’s traditional valuation metrics to the industry average may provide insight on a stock’s value in certain scenarios; however, it won’t work if you compare a wonderful business to that of a mediocre business.
TD Bank is a wonderful business that stands out from the pack, and I don’t believe it makes sense to compare it to that of its less wonderful peers. As Warren Buffett once said, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
Why has TD Bank’s valuation premium over its peers shrunk?
It all started with the CBC story released earlier in the year which showed that tellers were up-selling customers or adding services without their consent. Shares of TD Bank took a plunge, and it’s likely that many investors unfairly shunned the stock, even after it was discovered that the scandal wasn’t unique to TD Bank. It just happened that it was the first to be exposed!
After the dust settled with that fiasco, all the banks took a hit as fears over a Canadian housing meltdown mounted. To this day, there are still investors who are fearful of the Canadian banks because of this, but as more solid quarters are reported, it’s likely that fears will gradually turn to greed as the banks continue to deliver on a consistent basis.
Doe misplaced fears change the long-term fundamentals?
Not quite, especially in the case of TD Bank, which has a fantastic high-quality retail business and a growing U.S. presence, the strength of which will be exacerbated by Trump’s agenda, which I believe is still in the cards. Interest rates are also going up, which is a major plus for all banks.
Bottom line
It’s hard for me to visualize a realistic scenario in which the banks deliver sub-par returns over the long run, especially in a rising interest rate environment. Sure, the general public has their reasons to be fearful of Canadian banks, but I don’t buy it. I don’t think a violent housing meltdown is realistic at all; in fact, many pundits would agree that a gradual cooling of the housing market is the more probable scenario.
If you don’t buy into the doomsday predictions either, then it’d be a wise move to consider a bank at these levels, while everyone else is afraid. TD Bank is my top pick, since I believe will raise its dividend by the largest amount relative to peers over the next five years. The bank deserves a hefty premium over its Big Six peers, and over time, I expect this premium to return gradually over time.
Shares of TD Bank may not be the cheapest based on traditional valuation metrics; however, when you consider what you’ll get for the price you’ll pay, TD Bank is by far the cheapest bank, and I’d encourage investors to load up on shares today.
Stay smart. Stay hungry. Stay Foolish.
