Toronto-Dominion Bank
My colleague Grant Robertson reported on Wednesday that Toronto-Dominion Bank edged past Royal Bank of Canada as Canada's largest company, in terms of its market capitalization. I've often half-joked that the stock that sits atop the S&P/TSX composite index with the biggest weighting should always be avoided – and perhaps even shorted – but should this apply to TD?
Royal Bank ( full disclosure: I own this stock) is definitely the heavyweight champ over the longer term, dominating the top spot in the index longer than any other company. But upstarts have pushed the bank aside for brief periods, and they never seem to fare well once they do. The reason, as I see it, is because these upstarts tend to be driven by short-term euphoria rather than any real fundamental reason. And short-term euphoria has a nasty habit of disappearing – fast.
Nortel Networks Corp. dominated the index in the late 1990s and into the 2000s, before it went belly-up. Manulife Financial Corp. was the biggest stock in 2005, but has since fallen 50 per cent. Potash Corp. of Saskatchewan assumed the top spot in 2008, when everyone was convinced that fertilizer prices were going through the roof and never coming back. The stock has since slumped about 40 per cent. And don't forget about BlackBerry-maker Research In Motion Ltd. : It made it to No. 1 on the index in 2008, and has since fallen about 88 per cent.
Periodically ousted, Royal Bank always seems to come back – and indeed, it is on top on Thursday morning.
Nevertheless, TD represents a different take on this theory, since it, like Royal, is a bank. There is certainly no euphoria driving the stock. However, what's interesting is that TD has by far the lowest dividend yield among the Big Five Canadian banks, at just 3.8 per cent. The closest rival is Bank of Nova Scotia's dividend yield of 4.1 per cent. At the other extreme, Canadian Imperial Bank of Commerce's yield is 5 per cent.
TD's low yield suggests that investors have more confidence in the bank – and, in particular – the growth of its dividend. Now that it has become Canada's biggest, we'll soon see if this confidence is warranted.
So is skepticism about Canada's biggest company a crackpot theory? Maybe not. Research Affiliates, a California-based company that develops investment strategies and offers advisory services, has long contended that stock prices in all developed markets contain errors that revert to fair value over time. Their Research Affiliates Fundamental Index methodology instead values companies based on more fundamental measures, such as sales and dividends.
"Cap-weighted indexes are measures of the market, and thus are generally viewed as good benchmarks of market performance," the company's web site says. "As the basis for an investment strategy, however, cap weighting results in overweighting overpriced securities and underweighting underpriced securities."
David Berman