There are some stocks where the whole thesis for investing rests on one key factor. Often, things like patents and trademarks single-handedly hold up a company’s entire margin. If they are lost, then the company that owns them becomes nearly worthless. In this article, I will explore one stock that is intriguing right now, provided that one specific scenario is avoided. If this scenario doesn’t play out, then the stock is dirt cheap; otherwise, it is a confirmed value trap.
TD Bank
Toronto-Dominion Bank (TSX: TD) is a Canadian bank stock that has many things going for it. It has a cheap valuation (about 10 times adjusted earnings), several fast-growing segments, and a high dividend yield. However, it’s also embroiled in a major money-laundering scandal. It might eventually prove to have been a buy at today’s prices, but only if a “worst-case scenario” in the investigation does not play out.
Details on the investigation
TD Bank is being investigated by the U.S. Department of Justice (“DoJ”) for laundering money for drug cartels. Specifically, it is being investigated for laundering money for Chinese fentanyl cartels across the Eastern United States. Several bank employees were caught engaging in such practices in New Jersey in 2022 — this was a factor in the cancellation of TD’s First Horizon buyout deal. Later, similar infractions were found in New York and Florida.
TD admitted to the slip-ups at its branches when they first came to light. It has since booked a US$3.06 billion provision related to money laundering fines that it expects to take. If the fines stop at US$3.06 billion, then TD’s stock is cheap. The adverse scenario here is one where the fines don’t stop this year but spiral out of control to eventually reach tens of billions of dollars over several years. Such things have happened to banks in the past. For example, Bank of America took $30 billion worth of fines related to the SMC Scandal over a period of about a decade. If something like this happens to TD, then its stock will eventually prove not to have been a buy at today’s prices.
A cheap valuation
There’s one thing that TD undeniably has going for it: a cheap valuation.
At today’s prices, TD trades at
- 10 times adjusted earnings;
- 2.7 times sales; and
- 1.35 times book value.
These multiples are low — even by the standards of banks, which are generally cheap. As long as TD can avoid having the money-laundering fines spiral out of control, it’s a buy. I personally have bought the stock, as I think that the investigation will wrap up near the end of this year. However, there are real risks here. Jittery investors are best advised to stay away.
Foolish takeaway
TD Bank stock is a classic example of the complexity of analyzing stocks. It has all kinds of positives going for it, but last quarter, every single penny of potential profit was erased by the fine provision. It’s a tough one, for sure. I’m invested in it, but I wouldn’t recommend the stock to investors with a low-risk appetite.
