I haven’t been buying that many stocks these days. With the markets being fairly expensive, I’ve been putting more money in GICs. However, there is one stock I’ve been buying in my RRSP, because it got beaten down and could recover easily. In this article, I will explore this magnificent stock in detail and share why it’s an intriguing opportunity for risk-tolerant investors.
TD Bank
The Toronto-Dominion Bank (TSX: TD) is a high-yield Canadian bank that has been beaten down due to legal risks. Before going any further, I should say that when I call this stock “magnificent,” I mean primarily for financially savvy investors who are prepared to keep up with the news about the company. There are certain scenarios in which this stock will prove not to have been magnificent at today’s prices. While I consider the probability of these scenarios fairly low, it is definitely not 0%, so making an informed investment in TD Bank requires following the news consistently.
Basically what happened was that employees at some New Jersey TD branches were caught facilitating money laundering. This news broke in 2023, and didn’t have a major impact on TD’s stock price. It did eventually result in TD’s First Horizon deal getting scuttled, but that was taken as a positive: TD offered a very steep price for that bank. Things got out of control when the Wall Street Journal reported that TD’s money laundering issues pertained to fentanyl dealing. The potential for public outcry directed at TD seemed very real when the WSJ story broke.
So far, TD has booked $450 million for fines related to the money laundering investigation. Experts believe it will ultimately pay out over $2 billion if other investigations find TD culpable of wrongdoing. All considered, $2 billion in total fines wouldn’t be the end of the world for TD. However, if news reports caused mass public outcry, that could trigger loud demands for more/larger fines. If total fines went over $10 billion, then TD stock would be down for a long time.
Why I’m buying
I’m buying TD stock because it is rather cheap and worth the investment if the fines do not go beyond $2 billion. The stock trades at 10 times earnings today. If the total fines paid are only $2 billion, and they’re all paid in a year, then the “forward” P/E ratio (holding all else constant) is 12.5. That is merely a typical bank stock valuation. Also, many financial sub-sectors (especially investment banking) are performing well this year. TD just finished buying U.S. investment bank Cowen, so it stands to gain from the trends in the industry. Most likely “all else” won’t be constant: revenue will rise. So TD is valued basically on par with its peers using the P/E valuation method in a “$2 billion fine” scenario.
However, one flaw with the P/E ratio is that it doesn’t account for multiple years of future earnings. A $2 billion reduction in TD’s future profits does not change the discounted cash flow valuation of the stock much. So, TD is in fact cheaper than other banks if we assume that the “worst-case scenario” does not play out.
The trouble of course is that the worst-case scenario could play out. If the U.S. media “goes hard” after TD, it could stoke public outcry leading to more investigations. So if you invest in TD, you need to follow the news about the investigation. There is a low but not zero probability scenario in which bad publicity tanks the stock.
