By: Jeff Pollock
March 23, 2017
The liquidity offered in the stock market is a double-edged sword. On the one hand, few can resist the temptation to check the prices of the stocks they own on a daily (or even minute-by-minute) basis. This creates relentless anxiety, excitement, or anger, depending on the day. On the other hand, it provides investors like us the opportunity to take advantage of inefficient pricing at a moment’s notice.
Two weeks ago, shares of the Toronto-Dominion Bank (TD), arguably the most conservatively managed bank in North America, fell 5.3% in a single day, representing its largest daily drop since May 13, 2009.
The sell-off followed a story written by CBC earlier that day. The article alleged that TD tellers pursue high-pressured and unethical sales practices to meet their targets. In response, TD said that it has a robust system in place to track, monitor, and investigate customer complaints. They further revealed that just last year the bank received only a few hundred messages, despite serving millions of customers. For anyone with friends or family that work in the banking sector it should come as no surprise that bank employees face tremendous pressure to meet their targets. Challenging sales goals, however, does not legitimize anonymous allegations that TD Bank violated consumer protection laws with its cross-selling practices, and the stock market swiftly reacted to reflect this sentiment. Next month, the Financial Consumer Agency of Canada will undertake a probe to investigate these allegations further.
Nevertheless, when good companies do bad things, that are unlikely to recur, it often presents a buying opportunity for long-term investors, such as Vestcap.
In 2012, JP Morgan executed a poor trade involving credit default swaps in a saga now infamously referred to as the “London Whale”. Shares plunged almost 30% over a 2-month period, wiping out close to $55 billion of the company’s market cap. While the trade resulted in a loss of approximately $6 billion (representing only 11% of the total market cap that was lost), the bank nevertheless managed to earn $21.3 billion in profits that same year. Today, the stock is 170% higher than it was at the depths of the London Whale fiasco.
In 2010, following several traffic accidents, Toyota Motors recalled 5.2 million vehicles for defective floor mats, and then another 2.3 million automobiles with faulty accelerator pedals. The company’s stock subsequently dove 20%. However, one year later the US National Highway Traffic Safety Administration concluded that driver error or pedal misapplication were responsible for the traffic incidents, not Toyota Motors. Today, shares of the company are 50% higher, relative to the stock price’s trough during the early months of 2010.
In 2008, the Ontario Teachers’ Pension Plan attempted the largest takeover deal in Canadian history. Through making a leveraged buyout, it sought to buy BCE for $42.75 per share. Auditor KPMG, however, declared that the company would not meet its solvency tests given the $32 billion of required debt that would be required to close the deal. In one single day, 34% of the stock’s value was eroded and shares closed at $25.50. Investors that purchased stock that day picked up a 5.8% dividend. Today, their cash-on-cash dividend yield from that original investment has grown to 11% per annum following the company’s disciplined dividend increases over the past decade. Meanwhile, the stock price is 130% higher from its $25.50 low that resulted after the deal was cancelled.
These are just three examples of ‘good companies doing bad things’, but there are many more. At Vestcap, we actively look for securities that trade out of favour following non-reoccurring operational missteps that create steep selloffs. We have taken advantage of TD Bank’s recent share price weakness by increasing our clients’ portfolio weightings to the name. Going forward, we’ll continue to pursue this same strategy of buying good companies that are temporarily out of favour based on the strong historical track record that buying contrarian stocks accompany.
*Clients and this writer are shareholders of TD Bank and BCE.
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