Stock Analysis & Ideas

TD Bank: Are Analysts Mispricing the Stock?

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TD had a solid quarter, as it beat analysts’ expectations. However, it appears that both analysts and the market may be mispricing the stock when using an excess returns model to value it.

The Toronto-Dominion Bank (TSE: TD) (TD) is a leading provider of financial products and services in Canada. It is the sixth-largest bank in North America by branches and serves over 26 million customers. It operates through its Canadian Retail, U.S. Retail, and Wholesale Banking segments.

TD recently reported earnings, which beat expectations. Adjusted earnings per share came in at C$2.02, above analysts’ expectations of C$1.93. Revenue was C$11.26 billion, which also beat the consensus of C$10.18 billion.

TD’s share price is down roughly 1% year-to-date but up approximately 10% in the past year. Nevertheless, the stock may be attractively priced at the moment due to its recent pullback.

Is TD Bank Undervalued?

To value TD, I will use the excess returns model. This approach is more appropriate for financial companies because they tend to have volatile free cash flows. As a result, trying to create forecasts for them is futile. The excess returns model allows us to use historical numbers instead, which are actual results. There are a few steps to follow for this valuation method.

First, you calculate a company’s excess returns. Next, you calculate the terminal value. Add them up, and you get your valuation. Here’s how it works:

Excess Returns = (Average ROE – Cost of Equity) x Book Value Per Share
Terminal Value = Excess Return / (Cost of Equity – Growth Rate)
Fair Value = Book Value Per Share + Terminal Value

We will use the following assumptions for our calculations:

Average ROE: 14.7% (five-year average)
Cost of Equity: 7.8% (value taken from Finbox)
Book Value: $52.17
Growth Rate: 2.79% (used 30-year Government of Canada yield as a proxy for long-term growth expectations)

Now that we have our assumptions, let’s plug them into the formulas:

$3.6 = (0.147 – 0.078) x $52.17
$71.86 = $3.6 / (0.078 – 0.0279)
$124.03 = $52.17 + $71.86

As a result, TD is currently worth C$124.03 per share under current market conditions.

TD Bank’s Dividends

For income-oriented investors, TD pays a 3.71% dividend yield on an annualized basis. When taking a look at TD’s historical dividend yield, you can see that it has remained relatively flat:

However, at 3.71%, the current yield is on the low end of the range, indicating that income-oriented investors are paying a slight premium relative to yields they have been able to receive in the past.

Analyst Recommendations for TD Bank

The Toronto-Dominion Bank has a Hold consensus rating based on three Buys, 10 Holds, and one Sell assigned in the past three months. The average Toronto-Dominion Bank price target of C$102.82 implies 7.1% upside potential.

Final Thoughts

TD had a solid quarter, as it beat analysts’ expectations. Although analysts have a Hold rating with minimal upside potential, the excess returns model suggests that the market may actually be mispricing the stock by a larger amount.

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