Why TD Bank Might Be the Dividend Play of the Decade

Toronto-Dominion Bank (TSX:TD) has a 4.7% dividend yield, and the dividend is rising at a rate of 8% per year.

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Toronto-Dominion Bank (TSX:TD) is one of Canada’s best high-yield dividend stocks. It has a 4.7% dividend yield but, unlike many stocks with such yields, does not have a very high payout ratio. TD currently pays out a mere 48% of its earnings as dividends. That means it has a 0.48 payout ratio, which is well within the “sustainable” range.

Of course, there are other factors that you need to look at with dividend stocks in addition to the payout ratio. For example, you need to look at the stock’s earnings growth, profitability, and dividend growth. If a stock scores well on those factors and has a low payout ratio, it may be a good dividend play. Fortunately, TD Bank scores well on all of these criteria. For this reason, it may go on to become one of the best Canadian dividend plays of the decade.

Earnings and dividend growth

First off, let’s look at the growth. It’s one thing to know that a dividend stock has a high yield that is well covered, but ideally, we’d want that payout to grow over time. For this, we need to see some earnings growth. There are three pieces of good news here:

  1. TD Bank’s earnings have grown by 5.7% CAGR over the last five years and by 8.5% CAGR over the last 10. “CAGR” means compound annual growth rate; it’s an annualized return measure that can also be used for dividend growth.
  2. TD’s dividend has grown by 8% CAGR over the last five years.
  3. Interest rates have risen dramatically over the last 12 months, and lenders tend to make more money when rates are high than when they’re low. So, we’d expect TD Bank’s earnings growth to remain high going forward.

What these two factors argue is that A, TD has grown historically, and B, it’s likely to continue growing in the future. That’s very encouraging. However, it’s not the whole picture. If TD’s deposit interest rises above the interest it charges on loans, it could become unprofitable. So, we’ll need to take a look at how TD is doing in terms of profitability to say for sure it’s a safe bet.

Profitability

In the previous section, I said that Canadian banks tend to make more money with high rates than with low rates. That’s definitely true if we ignore the cost of deposits. However, when deposit interest rises, it squeezes lenders’ profit margins. And unfortunately, banks have to raise deposit interest in order to retain depositors, in periods when ever-higher yielding treasuries lead said depositors to greener pastures. This basic phenomenon explains why U.S. regional banks like Silicon Valley Bank and First Republic failed this year.

Fortunately, deposit interest has not become an issue for TD Bank this year. In the trailing 12-month period, the bank’s net margin was 29%. That is fairly high. It would have to come down significantly for “shrinking margins” to be a serious issue here.

Foolish takeaway

At the present moment, TD Bank seems to have it all. It has a high yield, dividend growth, and the earnings growth needed to support its dividend growth. In all likelihood, today’s shareholders will not only collect the dividend on offer but watch the payout rise as well. This could be one of the best dividend plays of the decade.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Button has positions in Toronto-Dominion Bank. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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