Banks have had a tough year so far in 2023, with the SPDR S&P Bank ETF (KBE -0.31%) down more than 20% versus a roughly 7% gain for the broader S&P 500 index. Even if you've never bought shares of a bank stock before, that might have you thinking about making a contrarian investment in the sector. You should probably err on the side of caution and opt for a bank like Toronto-Dominion Bank (TD 0.46%). Here are some important reasons why.
1. TD Bank is like buying two banks in one
Toronto-Dominion hails from Canada, where it is one of the largest banks in the country. That provides a solid foundation for the business. It also has a significant presence in the U. S., where its business is concentrated on the East Coast. Basically, in the U.S. market, it is a large regional bank. Given its footprint, there's room for growth as it expands its geographic reach.
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From a big-picture perspective, that means that TD Bank has a reliable core to bolster the company. And it has a solid engine to support long-term growth. That's a better mix than buying a giant U.S. bank, which would likely be fighting for market share after already saturating the U.S. market from coast to coast. And it is better than a regional U.S. bank, which wouldn't have the solid foundation that TD Bank has in its Canadian operations.
2. Canada is highly regulated
It is important to recognize that Canada's banking sector is not like the highly competitive U.S. banking sector. In Canada, strict regulation has effectively resulted in a small number of entrenched industry leaders. TD Bank is one of those leaders, holding the No. 2 position in the country based on deposits. This is one of the reasons the Canadian business is such an important factor.
There's a second reason, however. The highly regulated Canadian market is generally hyper-focused on safety. That focus pervades TD Bank's business, including its efforts to expand in the U.S. market. So as a first investment in the banking industry, you are erring on the side of caution by trusting a management team that isn't prone to taking unnecessary risks.
3. Better prepared than any other North American bank
Being conservative is good, but there are other Canadian banks that could make the same claim. And they, too, have reached into the U.S. market. But TD Bank still stands out right now thanks to the fact that it has the highest Tier 1 ratio in North America at 15.2%. The Tier 1 ratio is basically a measure of how well prepared a bank is for adversity, with higher percentages being better than lower ones. Given investors' obvious concerns about the banking sector as illustrated by the steep decline so far this year, it is probably a good idea to stick with companies that have robust Tier 1 ratios, like TD Bank.
4. A proven track record
Just how safe is TD Bank? Although there are no guarantees on Wall Street, a look back to the Great Recession is telling. While giant U.S. banks like Bank of America (BAC -0.21%) and Citigroup (C 1.41%) were forced to cut their dividends amid the financial crisis, TD Bank held its dividend steady right through that difficult period. But that was actually by mandate, because Canadian regulators didn't let banks increase their dividends. After that mandate was lifted, TD Bank returned to dividend growth.
Data source: YCharts
Note that TD Bank pays dividends in Canadian dollars, so the dollar value of dividends U.S. investors receive will fluctuate with exchange rates. Still, erring on the side of caution clearly paid off for income investors when you go back and examine the last big financial crisis.
5. A very attractive dividend yield
The last reason to like TD Bank today is its dividend yield, which is an appealing 5% or so. That's a little bit lower than what you'd get from Citi, but a fair bit higher than what Bank of America is offering. It appears to be a good compromise between risk and reward.
Data source: YCharts
TD Bank's yield, meanwhile, is toward the high end of the company's historical yield range. That suggests that the stock may be attractively priced right now. In other words, it could be just the contrarian bargain you think it is.
A safety-first bank pick
From a high level, banks are fairly simple to understand, but when you dig into the details it can get pretty complex. TD Bank offers investors a way to invest in the sector via a fairly conservative business that hews to Canada's conservative banking ethos and regulations. A historically high yield, strong Tier 1 ratio, and a blend of Canadian and U.S. exposure all add up to make TD Bank a solid first choice for investors new to the banking sector.
