Something’s up with Toronto-Dominion Bank TD-T, and it’s not the stock price. TD is trailing its Big Six peers so far this year by a wide margin, while short sellers are betting the stock will continue to struggle, offering a strong counterpoint to TD’s image of stability.
But investors may want to focus on the bank’s curiously low valuation and ask themselves if the selloff is overdone.
It’s not often that TD falls to the back of the banking pack in terms of share-price performance. Indeed, you’d have to go back to 2000 to find a year when the bank trailed all its peers for a full calendar year.
Three-and-a-half months into 2023, though, TD is the outlier. The share price is down 7.3 per cent so far, compared with an average gain of 4 per cent for its peers.
Equally concerning is the fact that short sellers, generally sophisticated investors who bet that a stock will fall in value, have taken a keen interest in TD.
According to S3 Partners, the New York-based financial data company, 104 million TD shares have been sold short on combined U.S. and Canadian exchanges. That’s up 36 million shares – more than 50 per cent – over the past 30 days.
As a percentage of tradable shares, or float, the current figure is 5.72 per cent. That stands out next to the bank’s closest peer, Royal Bank of Canada RY-T, at just 1.49 per cent, according to S3 Partners.
Short sellers don’t get everything right, of course. But their activity raises concerns that some investors may see challenges for the bank at a time when the broader sector is struggling with the knock-on effects of rising interest rates: the threat of a recession, soaring borrowing costs and simmering concerns about credit.
Investors have also been on edge since the failure of Silicon Valley Bank and Signature Bank last month after depositors fled, depressing valuations across the sector amid concerns about contagion.
Is TD in the crosshairs of investors who believe the bank is particularly vulnerable?
What’s more likely is that the stock is being weighed down by a couple of short-term challenges that have little to do with the bank’s long-term performance, setting it up as a bargain for investors with longer horizons.
For starters, TD owns a significant stake in Charles Schwab Corp. SCHW-N, the U.S. brokerage firm that has seen its share price flop 39 per cent this year, mostly since the SVB failure.
According to Gabriel Dechaine, an analyst at National Bank Financial, every 10-per-cent decline in the share price of Charles Schwab hits TD’s share price by about 1.5 per cent, which explains a large part of TD’s recent underperformance.
As well, TD is awaiting regulatory approval of its deal to acquire First Horizon Corp. FHN-N at US$25 per share. FHN is currently trading well below that takeover price, suggesting that investors believe the deal will be scuttled or renegotiated.
Analysts expect that if the deal proceeds at the agreed price, TD’s share price could suffer. That prospect offers a reason for some investors – say, those who have invested in FHN – to hedge with a bet against TD.
The deadline for the deal is currently set for May 27, a timeline that offers six weeks of additional uncertainty for TD investors.
In the meantime, it’s worth considering the opportunity here.
TD has traditionally traded with a healthy premium over most other Canadian bank stocks – based on estimated price-to-earnings ratios – because of the bank’s strong growth, gargantuan size and impressive U.S. retail banking footprint.
Now, the stock’s valuation is trailing.
According to recent figures from RBC Dominion Securities, TD’s valuation has slipped to just 8.1 times estimated earnings. That makes it one of the cheapest stocks among the Big Six on this measure, tied with Bank of Nova Scotia BNS-T and well below TD’s 15-year average valuation of 11.2 times estimated earnings. Canadian banks have a tendency to bounce back after lagging their peers.
No doubt, banks face challenges as economic clouds move in.
But as JPMorgan Chase & Co. JPM-N demonstrated Friday, the mood may be overly grim. The U.S. bank reported a surprisingly strong 52-per-cent increase in first-quarter profit, sending the stock on a 7.5-per-cent rally in afternoon trading.
That may be a short-term bounce. But long-term investors should take note.
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