Toronto-Dominion Bank (TSX:TD) and Royal Bank of Canada (TSX:RY) are two of Canada’s best loved bank stocks. Many Canadians hold the two stocks in their portfolios, either directly or through TSX index funds. It’s not surprising, because the two banks are ubiquitous, with branches coast to coast: everybody knows TD and Royal Bank. Both of these banks are quite strong and well positioned in the Canadian financial services market. However, I personally chose to “go big” on TD Bank last year, rather than buy TD and RY together.
Now, if you look at the chart above, you will see that Royal Bank has outperformed TD Bank by a considerable margin over the last five years, up 125% to TD’s 96%. It would seem that RY has been the clear winner between the two stocks. However, charts can be deceiving. First, TD has had a higher dividend yield than Royal Bank has had for most of the last five years. That narrowed the gap between the two stocks on a total return basis. Second, those who bought TD Bank shares late in 2024, like I did, realized a much better return than Royal Bank investors did this year.
While I’m not entirely sure that TD will continue outperforming Royal Bank for the remainder of this year, it’s worth exploring the reasons that I bought it last year, as they form a good case study in valuing stocks.
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Why I bought TD in late 2024
The reason why I bought TD late in 2024 was that the stock had gotten unjustifiably beaten down because of a fine and asset cap at its U.S. retail business. That business had been caught up in a money laundering scandal involving low ranking employees, which the U.S. Department of Justice (DoJ) saw the entire company as being complicit in. So, the DoJ fined TD $3 billion, and capped its U.S. retail segment assets at $430 billion. The fine took a bite out of 2024’s profits, while the asset cap prevented TD’s U.S. retail segment from growing.
As a result of the above, TD’s stock price fell all the way to $74 — a multi-year low. At that price, the stock was going for about nine times earnings. It looked too cheap.
Now, granted, TD had been beaten down for a reason. The asset cap prevented its U.S. retail segment — historically its biggest growth driver–from growing at all. It was quite a setback. However, to comply with the asset cap, TD raised considerable sums of cash by selling assets. It used these assets to fund a large buyback, which likely contributed to TD’s considerable gain for this year. Speaking of which, TD stock has outperformed the market this year, with roughly a 35% total return.
Royal Bank in the same period
The situation with Royal Bank in late 2024 was quite different. Facing few issues, the stock was priced to perfection. At 14.25 times earnings, it was even a little pricey by bank stock standards. The company had many things going for it — for example, it had recently bought out Bank of the West, a major California bank. However, the stock was priced with all of its advantages in mind. So, I passed on RY stock in late 2024.
Foolish takeaway
My experience with TD and Royal Bank stocks reveals an important lesson: often the best opportunity is that which is beaten down and out of favour. Overlooked stocks are often underrated, pricey stocks are often overrated. So, don’t assume that the most popular stock is the best one. Often, just the opposite is the case.
