Shopify (TSX:SHOP) is one of Canada’s most expensive stocks. Trading at 105 times forward earnings, 11.1 times sales, and 9.5 times book value, it is a truly costly asset. True, the company has the high growth to back up its high multiples, but the pace of growth is down from previous quarters. In 2020, SHOP grew its revenue by 86% year over year. In the most recent quarter, the growth rate decelerated to 25%. Were the growth to decelerate even further, then SHOP’s current valuation would begin to look questionable.
But fear not! If you are allergic to the idea of buying an expensive stock, you don’t have to buy Shopify. You don’t have to buy any other stock, for that matter, but you can find cheaper options. In this article, I will explore one bank stock that I find to be a more appealing value than Shopify today.
TD Bank
Toronto-Dominion Bank (TSX:TD) is Canada’s second-biggest bank by market capitalization and the biggest by total assets. It is involved in retail banking, brokerage services and investment banking in Canada and the United States. TD’s U.S. business generates about 40% of its net income, making TD “the most American of Canadian banks.”
TD Bank has experienced above-average growth for a Canadian bank over the years. In the last five years, it has grown its revenue and earnings by 7% CAGR — CAGR means compound annual growth rate. This is not exactly Shopify-calibre growth, but TD Bank stock is much cheaper than Shopify stock. Trading at just 10 times earnings, it’s a true value name with a high (4%) dividend yield.
Why it’s a good value
TD Bank stock is a good value because it has enjoyed relatively good growth, has high profit margins, and yet is inexpensive. At today’s prices, TD Bank trades at
- 10.2 times earnings;
- 3.2 times sales; and
- 1.4 times book value.
It’s a pretty modest valuation, yet TD has some growth and a 31% net income margin! Overall, it looks like a compelling package.
Risks to watch out for
Although TD Bank is an impressive bank in many ways, it does face several risks that investors need to be on the lookout for.
The biggest one relates to whether the current high profit margins can continue into the future. Although TD’s margins over the last 12 months have been high, Canada’s yield curve is inverted.
The yield curve is a chart showing the yields of different bonds ranked by maturity. The curve is “inverted” when it slopes downward (i.e., short-term bonds have higher yields than long-term bonds). This is the case right now.
Inverted yield curves are theoretically a problem for banks, because they borrow on the short end of the curve and lend on the long end. The yield curve has been inverted for over a year now, and so far, it hasn’t caused problems for Canadian banks, but we did see some issues for U.S. banks when their depositors withdrew their money, and the banks couldn’t pay them off. When banks don’t raise interest on their deposits, depositors tend to flee to treasuries, which creates pressure to raise interest rates in the future. That, in turn, reduces margins.
Another big risk is the possibility of a future recession. Bank earnings tend to go down a lot during recessions — TD is in the same boat as other banks in that regard. It isn’t a clear and pressing danger right now, but it is a long-term risk to watch out for.
