TD Bank: You Don't Have To Be A Genius To Build Great Income

Summary

• Canadian banks are known and beloved by dividend investors for their impressive dividend track records.
• Toronto-Dominion's first quarter results beat expectations but it was the 12% dividend hike that really excited me as a dividend investor.
• TD Bank is making strong inroads into the U.S. market and is positioned for further growth in its business as well as dividend growth for investors.
• To build great income all you need is patience, time and a stock solidly and reliably growing its dividend for years and decades.

Canadian banks with their century-long dividend history have rewarded investors dearly over decades.

Source: Marketing Mag

A year ago, I termed Toronto-Dominion Bank (NYSE:TD) the "best bank for dividend investors" and with the recently published earnings and dividend announcement the bank cemented that status once again. Hiking the dividend by 12% brings the yield to 3.6% (in CAD) and represented the single largest dividend increase over the last 6 years. Propelled by record U.S. earnings thanks to its strong U.S. footprint, the bank is positioned for further growth and will also benefit handsomely from Trump's tax reform. Valuation and dividend growth prospects signal an attractive long-term buying opportunity.

What is going on at Toronto-Dominion Bank?

In its latest FY 2018/Q1 earnings release, the company beat expectations top and bottom line. Net income rose by 15% boosted by very strong growth in TD Ameritrade (+23% Y/Y) and U.S. retail banking (+19% Y/Y) partially offset by a moderate 4% Y/Y growth in wholesale banking. While a one-time tax charge of C$405M affected overall profitability, this is good news for investors as it showcases the bank's strong standing in the U.S. and points to lucrative tax benefits from the U.S. tax reform going forward. More on that after we review the current quarter.

A record profit of C$952M in the bank's U.S. retail division (U.S. Retail Bank and TD Ameritrade together) lifted net income considerably. TD's rapid and significant expansion into the U.S. market has been a great strategic move. The segment is now contributing 41% of the bank's total earnings and is set for further growth.

Source: Toronto-Dominion Bank - Investor Relations - Equity Overview

Almost 2,400 retail locations is testament to TD's strong market position and being ranked a Top 10 North American bank as a Canadian bank is quite a feat. Interestingly, the company has more stores in the U.S. than in Canada and its U.S. branch is rapidly catching up on other metrics as well.

Over the years, the bank has evolved from a traditional dealer to a client-focused dealer by increasing its retail focus through various acquisitions and reducing overall risk. Out of Canada's Big Five banks, TD is the one focusing the most on retail and small business banking rather than capital markets and wholesale banking.

This does not sound as rewarding as high-profile investment banking but having been able to grow earnings at a 5-year CAGR between 8-10% clearly falsifies that assumption. As such the 15% EPS growth reported for the most recent quarter came in unexpectedly high and could signal a permanent shift to higher earnings growth momentum for the bank.

How about the U.S. tax reform?

With a significant amount of earnings originating in the U.S., the bank is set to benefit substantially from the U.S. tax reform. CFO Riaz Ahmed estimates that by significantly lowering the bank's U.S. retail bank tax rate, it can expect an annual benefit of up to C$240M and up to C$300M if including the bank's stake in TD Ameritrade.

This translates to a full-year EPS impact of around C$0.16 or, based on the latest declared dividend, represents 6% of its annualized dividend. As the bank continues to grow its U.S. operations that tax-driven earnings boost will scale up accordingly.

Dividend Growth is in the Teens

The company currently boasts a forward yield of 3.6% thanks to today's announced 12% dividend hike and has been growing its dividend by an annualized growth rate of 10% over the last 20 years.

Source: Toronto-Dominion Bank - Investor Relations - Equity Overview

That impressive growth in the dividend growth is fully supported by growing earnings as mentioned above. The company is targeting a payout ratio in the 40% to 50% range. In Q1/2018, the dividend payout ratio was at 38% and thus below the company's target corridor. Factoring in the increased C$0.67 quarterly dividend would have resulted in a payout ratio of 43%, right at the sweet spot of that range.

The bank's dividend increases have been occurring like clockwork and for dividend investors who want to experience the power of compounding dividend growth with a company solidly and reliably growing earnings for decades, TD is the place to be. A simple model, using CAD amounts, shows potential dividend returns for an investor starting out with TD right now with a 3.6% starting gross dividend yield.

Reinvesting the dividends every quarter (assuming you are with a broker where you can buy incremental shares), results in a personal net YoC of above 11% assuming the bank continues to grow its dividend at a 10% clip. Also, not factoring in any capital appreciation or exchange rate effects, an investor already received more than 60% of his initial investment over that time.

These results are already impressive but it gets better yet equally simple if we start investing additional capital into the stock every quarter. Here are the parameters:

• Starting yield: 3.6% gross
• Initial investment: $1,000
• Ongoing quarterly investment: $500
• Reinvest dividends every quarter
• 10% dividend growth
• 15% Tax rate
• Exchange rate and stock price appreciation are not considered

After 10 years, this results in the following:

A YoC of 8.9% paired with total invested capital of $21,000 is generating annual dividends of $1,857 or roughly $460 on a quarterly basis. At current prices, the latter would be sufficient to buy 8 more shares just with the quarterly dividend.

Admittedly, that scenario is making two very strong assumptions: First, 10% dividend growth over 10 years is a challenging task but based on the bank's track record and growth potential certainly achievable. Secondly, the model simplifies by not factoring in an appreciating stock price. Naturally, a higher stock price means that the dividends we receive and capital we contribute will buy less and less stock. Assuming the stock grows by 8% p.a. would for instance only allow us to buy close to 4 shares or almost half of what the model is factoring into. A future and revised model will account for that parameter as well.

Despite these constraints, the power of compounding dividend growth becomes clearly evident. Leaving the parameters set as mentioned above and changing the dividend growth assumption to 8% would already result in a remarkably different picture.

After 10 years, 2pp lower dividend growth per year translates into an annual dividend that is 18% lower. That differential will only widen further as the years go by. Thus, for a long-term oriented portfolio dividend growth is much more important than a high starting yield. With TD Bank, we get a market-beating starting yield of 3.6% combined with 10% annualized dividend growth. A very powerful combination and a very easy way to experience the power of dividend growth investing.

Canada's "best bank for dividend investors" goes ex-dividend on April 9 with payment due end of April. Given the favorable macroeconomic environment in both the U.S. and Canada, the bank is expected to continue on its growth path.

To keep track of dividend payment and ex-dividend dates, I use the Dividend Calendar & Dashboard Tool, which shows my expected dividend payments, in this case for February 2018. I'd be happy if you download the free tool and give it a try on your own.

Similarly to the Royal Bank of Canada, TD is a top quality stock at a cheap price. It is currently trading at around 14 times earnings and thus in line with its Canadian peers. Its higher valuation is more than justified by its higher dividend growth and potential future growth in and catalysts from the U.S. market.

TD PE Ratio ((TTM)) data by YCharts

The bank’s avenues for growth are manifold and paired with the bank’s traditional strength and stability driven by its major retail focus will be providing plenty of income and growth for savvy investors that are willing to accept exchange-rate risks.

Investor takeaway

You simply can't beat the Canadian banks.

Now that all of the Big Five have reported earnings with all of them proving analysts wrong and posting higher than expected profits, all except Bank of Montreal (BMO) also hiked their dividend: Canadian Imperial Bank (CM) by 2.3%, Royal Bank of Canada (RY) by 3%, Bank of Nova Scotia (BNS) by 3.8% and TD Bank by a staggering 12%. TD Bank clearly stands out from the pack here, which also does not change if we consider that the others typically announce two similar-sized dividend hikes over the year.

Overall, favorable macroeconomic conditions in Canada as well as rising interest rates in North America and the U.S. tax reform have helped and will help TD to further expand margins and increase profitability while at the same time managing risk and keeping loan losses under control.

It is surprising to see that now that the market is potentially expecting 4 instead of 3 dividend hikes, all major North American banks are selling off although that should clearly help them to expand margins.

You don't have to be a genius to build great income.

In fact, it is probably the simplest task you can think of. All you need is patience, time and a stock solidly and reliably growing its dividend for years and decades. With TD you get the latter. You are responsible for the first two ingredients.

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Analyst’s Disclosure: I am/we are long CM, RY, BNS, TD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

I am not offering financial advice but only my personal opinion. Investors may take further aspects and their own due diligence into consideration before making a decision.

Comments

[Rooney McAroni]

Hi Stefan,
I don't understand your charts.
You write that you have a starting yield of 3.6 %.
But the charts show a much smaller number for YoC (than 3.6 %) for several years.
Please explain to a stupid reader.

Long TD (and the other 4).

[Sugar Charlie]

The Big-5 Canadian banks are an oligopoly in Canada, and TD is the best of the bunch overall. You get, periodically, scare pieces about the Canadian banks in the financial media, including some in SA,,especially in foreign media. Often the fears relate to concerns about the impact of risks to housing prices, especially in the Vancouver and Greater Toronto markets. But these anxieties do not take enough account of the geographical and sector diversification of the business operations of the Big 5, nor of mortgage-loan insurance and large down-payments on home purchases. So they tend to be exaggerated. Of course banks are cyclical investments because the economy is cyclical. But over any reasonable period, the Big 5 Canadian banks are, historically, very good investments, and this is well understood by Canadian money-managers and individual savers. Debates in Canada tend to be about general sector valuation and relative individual valuations at any given moment in time, and about differing business mixes (as to which Scotia is the main outlier because of its significant non-N.A, banking operations).

[Stefan Redlich]

Thanks Charlie for that helpful account. All the best :)

[Veritas1010]

15% “skim”.

[Sugar Charlie]

Don't you get a U.S. tax-credit for tax paid to foreign governments on foreign investment income, such as dividend income?

http://bit.ly/2dB8Ra8

[alacer]

TD looks good - has a ROIC of 11% with 1y GAP. (for definitions of these terms see http://bit.ly/2FPh1rc). But investing from the US won't Canada skim 15% off any gains?

[bpither]

TD - As a CDN this is my largest holding since 2009 ... absolutely brilliant divvy increase ... another $616 for me! I'm a customer too and the latest credit card offer from TD Visa offers a 9% cashback for the first three months in gas groceries and recurring bills up to $3500. You read that right. Only in Canada https://go.td.com/2FR0W4j

[Lone Wolf Capital]

Long time holder in my Never Sell portfolio

[Veritas1010]

If you have an understanding of foreign financials consider Nordea and Svenska Handelsbanken.

Both beaten down with excellent stewardship and capitalization ratios.

They both go ExDiv in a few weeks. High payout, high foreign taxes. ADR fees on the latter, not sure about Nordea. They pay only once yearly in the time honored European practice, (but strange practice to US investors).

Nordea especially has a lot going for it on growth too. Nordea had been based in Stockholm, is moving for more financial freedom to Helsinki, Finland. SH is Swedish based, in Stockholm I believe.

disc.: long Nordea (NRBAY adr), Svenska Handelsbanken (SVLNY adr).

[Thacher]

Hello Stephan:
it’s my understanding that the Canadian government levies a 25% tax on all dividends paid by Canadian companies to U.S. investors. Is that correct?
Thanks,
Larry

[CanuckNick]

If you hold it in a registered savings account you won't have to pay taxes like we don't pay taxes if my AAPL stock gives me a dividend as long as I hold it in my RRSP (Registered Retirement Savings Account). MY TFSA & your Roth account dividends will be taxed. Both countries have agreed on this bilateral deal.

[traderjim7]

Yes, Fidelity takes 25% of my TD and RY dividends and sends it to the Canadian government.

[Dividend Latitude]

Stefan,

Thanks for the write up on TD, my only bank stock. There are only 3 stocks in my portfolio to which I will add right now, since the markets are so high. And TD is one of those 3! The current price is reasonable (but not cheap)

[xKaotic]

Does investing in any of these Canadian banks result in foreign withholding taxes for USA based investors?

[Veritas1010]

15% foreign tax withholding since America and Canada can’t get a business positive quid pro quo like the US and the U.K.

You should know the rest of the drill, single tax credit $300/dual tax credit $600. Beyond that in foreign deductions, meet and greet IRS Form 1116, a complicated and confusing form that uses a formula for your excess payments based upon your gross income.

Do not let people tell you they simply run it through Turbo Tax and you get all your foreign withholding taxes credited back - wrong! The IRS is not stupid.

However, I accept this as I always own good quality foreign entities. Remember though diversification can become “diworseification” if not careful.

Also, there may be ADR fees which are non-deductible, but if TD is directly listed on the NYSE that may not be as likely (for some foreign stocks ADR fees grabbed by the banks can be as high as 14.99%). Note, the SEC doesn’t require the “black box” foreign bank repository to inform you before, after or during purchase. Your brokerage houses won’t either.

Sweet.

Fun, eh?

Just so you “know before you go”. All things I have learned along the way to getting there

Yields to you therefore can be, (my experience, on-average), - 0.05% to -1.25% less overall depending on the initial foreign tax withholding rate. In this case “only” 15% rather than let’s say France or Finland at 30% + ADR fees. But, you must factor this in, failure to do so gives you an illusion that you are cleaning up on some of these foreign stocks as they honestly do pay more - problem is you are not getting it really. It is an adjusted figure ultimately, and a variable number based on your income and individual tax circumstances year to year.

“Do your own due diligence”. I am not an accountant nor an advisor. I do not own TD, but do own more than one Canadian utilities AQN, NPIFF, green energy companies. I am interested in TD however have been for to long a while ~ personal inertia.

Hope this helps some.

[hhdash]

SO FAR SO GOOD---HAVE BEEN A USA AND CDN BANK INVESTOR FOR 30 YEARS BUT ----WHAT IS THE MAXIMUM % OF A PORTFOLIO THAT SHOULD BE INVESTED IN FINANCIALS ????

[CanuckNick]

BTW I bought TD last year at $66. Turned into one of my biggest plays. Love the dividends which gave me two shares each ER :) . Plus the fact that it has grown from $66 to $76 is not too shabby! ;) I have a 5 year retirement plan so TD will grow over the years to form 15% of a six figure portfolio

[M Barbon]

Are you not concerned about having too much concentration in a single stock? especially given that it's an accumution after small period of time. I personally worry if I go over 5% (but I use purchase price not current price).

[Robert Allan Schwartz]

"Are you not concerned about having too much concentration in a single stock?"

Is Warren Buffett concerned about his concentrated positions?

[M Barbon]

Yes, Warren is probably over concentrated in insurance.. however, his purchase we're done over many years. plus if you consider his purchase price, it may not be....

On the flip side, if one is to be over concentrated in a stock, TD is an excellent pick. As the analysis done above, it's very well run.

In addition, residing in Canada it's very tough to be diversified with a good balance sheet given the companies we have.

[CanuckNick]

Good article.
Two questions:
1. Looking at past years, is it possible to project five year earnings with some accuracy?
2. How would you compare RBC to TD?
Thanks!
Am now following you :)

[A Bunch of Dingbats]

TD One of the top 10 banks in America with over 1700 locations in the US and 1150 in Canada. They just do things better, over all better than most.. and they will continue to out perform as they have long before i first opened my first bank account with them back in 1972...and long held stock since 1982. I've made a small fortune. Their One of the best! Long TD

[Stefan Redlich]

Oh Wow, since 1982. That is impressive. Your dividends have probably increased by factor 50 or so? Congrats on such a great investment and not having sold it in between!

[Herbert Gamache]

Thank you for this very nice posting on TD, for which I totally agree. I have been a TD investor and re-investor for 5 + years and am completely satisfied with its performance. Furthermore the future, to me, looks very promising.

[Stefan Redlich]

Thank you Herbert. I wish I were more patient in buying TD yesterday but the report and the dividend increase felt so good, and the price as well, that I thought the stock price will get a boost as well. So now I am holding to see if it maybe drop more if market volatility persists. I wonder what happens on Sunday in Italy though.

[User 34796245]

Thank you for writing about a Canadian bank. I am following you now.

[Stefan Redlich]

Thank you. I also wrote about another Canadian Bank (RY) two days ago if you want to check that out as well ;)

[The_truth_unc0vered]

Totally agree: with time and patience on your side even financially uneducated people (like myself) can turn an investment into an astounding success that can beat the annual performance of most, if not all multi-billion dollar fund managers, as long as you let it compound!

[Stefan Redlich]

The beautiful power of compounding. So easy to benefit from yet only few people really do so. In Germany, even those rare investors who do own stocks, do not really get that concept as they think that if you make 10 or even 20% profit you have to sell immediately and dividends are there to spent. Well, they certainly can be used for that but if you follow the maxim just to invest as much capital as you can afford not to need over the next 5 years, the income should only be used for reinvestment in my opinion.

[The_truth_unc0vered]

Like Einstein said: Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it.

Who am I to argue with Albert? ;-)

[G. Blair Bauer]

Are the Canadian banks more honest than the American banks? I really got burnt in 2008.

[Stefan Redlich]

We'll see. Right now, we are all getting burned with protectionist Trump politics, which is a much greater concern to me. It is so one-sided and once other economic regions and countries follow this will hurt everybody but Trump is too naive to understand that apparently.

[G. Blair Bauer]

Stefan,totally agree. Wish Trump was forced to show his tax returns;I'd like to know if he is benefiting from this. His 6 bankruptcies don't make me comfortable here...

[Stefan Redlich]

Well, just hoping he won't be responsible for the Mother of All Bankruptcies, in symbolic terms, ruining the global economy and trade by shifting towards protection would certainly certify him accordingly...

[correct way to invest]

When will these banks ever get the credit of lesser quality banks like jp Morgan and wells

[Stefan Redlich]

That's a good question! But I like their "under-the-radar" standing as it allows us to buy them at much higher yields with similar growth compared to U.S. banks. If you want income, this is the way to go. If you want capital appreciation and no FX exposure, US banks are the better option

[dunnhaupt]

Sure, TD raised its dividend "by a staggering 12%", as you say, but they needed to catch up. Even after that raise they are still at the bottom of the 'Big Five'. TD now pays 3.6%, but RY pays 3.7%, BMO pays 3.9%, BNS pays 4.1%, and CM pays 4.6%.

[Stefan Redlich]

That's true but they have the fastest dividend growth and are set to benefit most from the tax reform going forward. Now that Trump's protectionist ideas are top story though, all stocks are suffering and better prices will be on the table shortly as everything gets sold.

[astronaft911]

All the dividends are below those banks 5year average payments. I am long TD since Brexit morning, but I am waiting to see what happens with Canadian economy this year.

[Kenyatta]

You did not mention the effect of the tax deducted from the divided. With that, the long term benefit is less.