Written by Kay Ng at The Motley Fool Canada
Toronto-Dominion Bank (TSX:TD) stock is down approximately 8% in the last 12 months compared to the Canadian stock market (using iShares S&P/TSX 60 Index ETF as a proxy), which is essentially flat. TD stock’s dividend wasn’t enough to cover the declined price, because the market also paid quarterly cash distributions. So, based on total returns, the market maintained as a winner in the period.
TD and XIU 12-month data by YCharts
It wouldn’t be appropriate to just give up on TD stock because of its underperformance in a short period. After all, stocks are long-term investments that ultimately perform largely based on the results of the underlying business. Although the Canadian bank stock returns still underperformed the market in the last five-year period, it outperformed in the last three- and 10-year periods. It goes to show that it could work in investors’ favour by buying the dip on TD stock.
TD and XIU 10-Year Total Return Level data by YCharts
Get more dividend income
Buying the dip in TD stock results in a bigger dividend yield, calculated by the annualized dividend per share divided by the current stock price. The decline in the stock in the last year has boosted its dividend yield to north of 4.7%.
Importantly, TD Bank pays a healthy dividend that it has increased over time. Although it paused dividend hikes at times of high economic uncertainty, it still managed to increase its dividend by about 9.6% per year over the last 20 fiscal years. That’s a solid dividend growth rate backed by earnings growth. Its more recent 10-year dividend growth rate is approximately 9%, which was supported by adjusted earnings per share growth of close to 8.5% per year.
To be cautious, when there is a higher risk in the economy, the regulator, Office of the Superintendent of Financial Institutions (OSFI), would request TD and other federally regulated financial institutions to pause dividend increases and stock buybacks to improve the stability of our financial system.
Enjoy better value in TD stock
A lower stock price also results in investors getting a better value for the stock based on the normalized valuation. It is true that in the current macro environment, under rapid increases of interest rates, the banks are experiencing higher loan-loss provisions. This means that the banks have to account for a higher percentage of bad loans.
For example, in the last reported quarter, TD Bank’s loan-loss provision was $766 million (up from $351 million in the prior-year quarter). To put it in more perspective, its fiscal year-to-date loan-loss provision (as a percentage of average net loans and acceptances) was 0.32% versus 0.08% a year ago, while its net impaired loans (as a percentage of net loans and acceptances) was 0.22% versus 0.20%. This cuts into its earnings, but it still maintains profits that cover its dividend with a cushion. This fiscal year, its payout ratio is estimated to be about 63% of earnings.
When risks are lowered, or the economy improves, the bank would lower its loan-loss provisions, which would bump up its earnings. At that time, the bank stock valuation would be normalized, equating to a target stock price of about $100. So, at about $81 per share at writing, TD stock trades at a discount of about 19% from its normal valuation — a target price-to-earnings ratio of roughly 11.7.
TD stock is a decent buy at current levels for income and total returns. Long-term investors can consider buying the dividend stock on weakness.
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