Do you ever wonder which stocks the average Canadian investor owns? The financials sector makes up about 35% of the Canadian stock market, using the iShares S&P/TSX 60 Index ETF as a proxy. So, it’s common sense that the average Canadian stock investor owns some large financial stocks.
One of the top financial stock components of this exchange traded fund (ETF), which appears to be cheap right now, is Toronto-Dominion Bank (TSX:TD).
The big Canadian bank stock makes up about 5.3% of the XIU ETF. Unlike some of its peers, the stock hasn’t climbed much higher after reporting financial results for its fiscal third quarter.
Why is TD stock cheap?
Perhaps what jumped out to investors was the reported net loss of $181 million for the quarter. Its reported revenue was $14.2 billion – 9.8% higher year over year.
What pulled down earnings big time was the provision for investigations related to the bank’s anti-money-laundering program of $3.6 billion, which equates to $2.04 per share. Hopefully, this will be a more or less one-time issue that doesn’t come back for a long time.
The provision for credit losses of $1.1 billion, 40% higher than a year ago, also did not help. The adjusted net income came in at $3.7 billion – essentially flat versus a year ago. This provides a better picture of the North American bank’s normal earnings power.
The money-laundering investigation by regulators is a headline risk that will likely continue to weigh on the stock in the near term. That said, in the past, there have been other North American banks hit by this kind of issue, which has proven to eventually come to pass.
In the meantime, Canadian investors can buy a cheap bank stock that earns durable profits.
How cheap is TD stock?
In the short term, analysts think TD stock is fairly valued. Longer term, the stock appears to be cheap. How cheap could it be? We would need to make some assumptions.
TD Bank’s diluted earnings per share (EPS) rose almost 15% per year from fiscal 2019 to 2022. Let’s be more conservative and assume that the fiscal 2021 earnings is a demonstration of its earnings power. Its fiscal 2021 diluted EPS was $7.72.
The bank’s long-term normal price-to-earnings ratio is approximately 13. That makes a fair stock price target of roughly $100 per share. This means the Canadian bank stock is undervalued by about 20% at about $80 and change per share at writing.
If TD stock normalizes over the next three years, it can deliver total returns of more or less 12%. Some returns are expected to come from price appreciation from earnings growth and valuation expansion, and a good portion will come from its dividend of almost 5.1%.
Foolish investor takeaway
Investors will need to be a little more patient with TD stock as it slowly puts the anti-money-laundering issue behind it. Its fiscal year-to-date results include solid revenue growth of 11% year over year and flat adjusted earnings per share of $6.09, while the stock is down 6% calendar year to date.
It is the right time for Canadian investors to own this undervalued dividend stock if you have an investment horizon of at least three to five years to allow for the A-grade bank to prove itself again. Currently, investors get paid well to wait with a nice dividend yield of nearly 5.1%.
