TD Bank (TSX:TD) is down about 25% from its all-time high. Contrarian investors seeking good dividends and a shot at decent capital gains are wondering if TD stock is now undervalued and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) portfolio focused on passive income and total returns.
TD stock
TD trades near $80.50 per share at the time of writing, compared to more than $108 at the height of the post-pandemic rally. The stock picked up a bit of a tailwind over the past couple of weeks, but it still isn’t far off the 12-month low of around $76.
TD is best known to Canadian investors for its domestic retail business, But the bank actually operates more branches in the United States. The company built the American operations over the past 20 years largely through strategic acquisitions focused on the east coast of the country running from Maine down to Florida.
Challenges
Last year, TD abandoned its US$13.4 billion plan to acquire First Horizon, a U.S. regional bank with about 400 branches in the southeastern states. The deal would have made TD a top-six bank in the American market.
Management cited regulatory hurdles as the reason for terminating the deal. TD just announced it is setting aside an initial $450 million to cover a potential fine connected to an anti-money-laundering probe by U.S. regulators.
The issue is one reason TD’s stock is out of favour. Investors might be sitting on the sidelines until there is clarity on the result of the investigations. In addition, the termination of the First Horizon takeover forced TD to scale back its guidance for earnings growth.
TD is sitting on a large capital cushion that will enable it to ride out any economic turbulence that could be on the way if interest rates remain at elevated levels. TD and its peers have increased provisions for credit losses in recent quarters as more borrowers have run into trouble making payments.
The Bank of Canada and the U.S. Federal Reserve raised interest rates aggressively over the past two years in an effort to cool off the economy and bring inflation under control. Economists broadly expect the central banks to start cutting rates in the back half of this year to avoid pushing the economy into a recession, but inflation remains at 3.5% and 2.9% in the U.S. and Canada, respectively, as of the March 2024 reports. This is above the 2% inflation target.
If the central banks can reduce rates and orchestrate a soft landing for the economy, TD and the other banks would benefit as fewer borrowers would likely default. In that scenario, TD stock is probably oversold right now.
Persistent inflation could force the central banks to keep interest rates higher for longer than anticipated. The risk is that rates will be high at the same time the economy starts to tank. This could lead to a wave of bankruptcies.
Dividends
TD has a great track record of dividend growth. Investors who buy the stock at the current level can get a 5% dividend yield.
Should you buy TD now?
Investors should expect ongoing volatility until there is more clarity on the outcome of the investigation by regulators in the United States. Bank stocks in general could see more turbulence if inflation remains near 3%.
That being said, a quick look at the long-term chart of TD’s share price suggests that buying the stock when it is out of favour tends to be a winning move for patient contrarian investors. I wouldn’t back up the truck today, but investors who are comfortable with a 5% yield might want to start nibbling and look to add to the position on any additional downside. The surge in bank stocks that occurred in the fourth quarter last year is a reminder that sentiment can change quickly.
