Toronto-Dominion Bank (TSX:TD) stock is severely lagging its sector this year. Down 9.7% when the TSX financials subindex is up 5.12%, it is underperforming by 14.82%.
If you’ve been following the news on TD stock recently, you’ll probably have some idea as to why this is happening: the money-laundering investigation.
The U.S. Department of Justice (DoJ) found several TD branches aiding a U.S. money-laundering ring in 2022. TD’s stock experienced some volatility when all of this came to light. Things started getting extremely ugly when the Wall Street Journal reported that the DoJ’s investigation related to alleged fentanyl dealing. Supposedly, TD employees helped Chinese traffickers launder funds. This news triggered a 6% one-day selloff.
Flash forward to today. TD stock is currently at $77.38, up 3.5% from its lows set a few days after the WSJ story broke. Things look better than they did a few days ago. But will TD fully recover? In this article, I will explore that question, ultimately concluding that the nation’s second-largest bank will recover, but maybe not quickly.
Reasons for the selloff
TD Bank’s recent selloff was directly attributable to the WSJ’s reporting. There was no other material news about the company at the time the story broke, so either a major investor sold to raise money for something else or the bad news caused investors to change their minds about TD.
Looking a little further back, some weakness in TD Bank stock was observed due to poor earnings performance two quarters ago. The company reported some non-recurring expenses that caused its profit to decline, although earnings shot back up in the subsequent quarter.
How TD is responding to the investigation
TD appears to be cooperating with the U.S. DoJ. The bank’s public statements have a tone of “we need to do better,” and it is already booking money related to potential future fines. So far, TD has booked $450 million. It says that it expects to book more than that because other investigations are underway. $450 million is simply a floor estimate. National Bank analyst Gabriel Dechaine recently said he expected TD to pay $2 billion. That figure is being widely quoted and appears to be a “consensus estimate” among Canadian bankers.
TD stock: Valuation in light of the investigation
Currently, TD stock trades at 9.97 times earnings and 1.28 times book value. This valuation makes TD among the cheapest banks in its peer group. Apart from TD, large North American banks spent the last six months rallying. Reasons for this bank rally included flattening of the treasury yield curve, high growth in investment banking fees, and fading memories of the Spring 2023 banking crisis. At the lows in 2023, big banks traded at less than 10 times earnings on average; today, they’re around 12.5 times earnings.
Foolish takeaway
TD is clearly cheap, going by today’s price and last year’s earnings. The question is whether coming fines will diminish its earnings power enough to negate the cheap trailing valuation. If it only takes $2 billion in total fines (the expert consensus), then TD’s forward price-to-earnings ratio is 12.5, assuming earnings are otherwise unchanged. In this scenario, TD is valued much like its peers are.
But if the money-laundering scandal spirals into a massive series of fines, then TD could still be too expensive. A lot rests on whether TD pays just the expected $2 billion or ends up in a Wells Fargo-style multi-year scandal, with fine after fine being added as more jurisdictions seek a piece of the pie. This fact makes TD stock riskier than average.
Personally, I’ve been buying TD stock. The investment will succeed if we get the consensus scenario rather than the worst-case scenario. However, I wouldn’t recommend this stock to an average investor, at least not at an above-index weighting. The DoJ’s investigation will be in the news for many months, and TD will be volatile on days when the news is bad. There’s an intriguing opportunity here for investors with high-risk tolerance, but it’s not for everyone.
