Shares of Commonwealth Bank of Australia (ASX: CBA) have been slammed recently. Although they have managed to recover 11 cents or 0.15% of their value today, they find themselves down more than 3% over the last week after they experienced a painful 1.6% drop on Monday. While some investors will no doubt see this as a golden opportunity to buy shares on the cheap, I would urge you to reconsider.
A rotten egg?
As it stands, Commonwealth Bank is still seen by many investors as the "go-to" stock for solid, fully franked dividends and 'security'. After all, it is Australia's largest bank stock. However, the reality is that investors who buy today could actually be committing themselves to below par returns for the foreseeable future!
Currently trading for $79.03, the bank's shares are trading on a price-earnings ratio of 14.9x and a price-book ratio of 2.6x – both of which seem excessive considering the bank's limited growth opportunities in the near term. To begin with, there have been signs of bad debt charges rising which will impact overall earnings while competition across the sector continues to heat up. This should also impact the profits Commonwealth Bank can make on its loans.
Then, you also need to consider the likelihood that each of the big four banks will be required to hold more capital in reserve in order to protect against a possible economic downturn. In fact, some estimates suggest CBA, Australia and New Zealand Banking Group (ASX: ANZ), Westpac Banking Corp (ASX: WBC) and National Australia Bank Ltd. (ASX: NAB) could be required to hold around $41 billion in additional capital. This could not only impact their ability to raise or even maintain their current dividend payments, but could also dent their return on equity.
Finally, who could look past Commonwealth Bank's dangerous exposure to Australia's red-hot property sector. With more than 25% of the Australian mortgage market, the bank would likely be amongst the hardest hit should cracks start to appear. With shares currently trading at over $79 each, I hate to think how far they could drop in such circumstances.
