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What you should know about Commonwealth Bank of Australia

Commonwealth Bank of Australia (ASX: CBA) is Australia’s premier banking company, and the tenth largest bank in the world by market capitalisation, with the total value of its shares exceeding $120 billion.

Commonwealth operates subsidiary banks in New Zealand, Indonesia and China, as well as having Commonwealth Bank branches established in London, New York, Tokyo, Singapore, Hong Kong, and Auckland. Commonwealth also has overseas life insurance operations, in addition to domestic subsidiaries Colonial First State (ASX: CFX) and Bankwest. Commonwealth also operates Commonwealth Securities, voted Australia’s Best Online Broker by Money magazine for the seventh year in a row.

Its position as the largest bank in Australia means Commonwealth also owns small portions of a variety of Australian companies, including ARB Corporation (ASX: ARP), QBE Insurance (ASX: QBE) and The Reject Shop (ASX: TRS). Budding investors may find it useful to follow a list of Commonwealth’s acquisitions and sales to find different companies to add to their watch list.

During the last financial year (2013), Commonwealth hit another record profit milestone, earning $7.8 billion. To put it in perspective, this is about 4.6% of Australia’s entire GDP. The 2013 milestone broke the previous record set in 2012, and the bank is on track to deliver another record with an estimated $8.3 billion in profit for FY2014. Trading on a price to earnings equation of 15.04, Commonwealth also appears reasonably valued, despite many analysts’ claims to the contrary.

In 2013, Commonwealth’s earnings came primarily from interest ($13.94 billion) and other banking income ($4.22 billion), followed by funds management ($2.14 billion), insurance ($1.03 billion) and investment experience ($0.15 billion). Its primary liabilities were operating expenses ($9.60 billion) and loan impairment ($1.08 billion), followed by tax of $2.97 billion. Commonwealth also pays out 75.4% of its profit in dividends for a yield of around 5%, fully franked.

As numerous analysts have noted throughout the past year, Commonwealth has already trimmed as much as reasonably possible from its loan impairment costs and boosted productivity significantly. It remains to be seen exactly where Commonwealth will generate earnings growth from after this year is out. Productivity boosts are always on the table, and customer satisfaction surveys can increase loan income and market share, but without a generalised pick-up in credit growth in Australia, Commonwealth’s earnings growth may slow. Indeed, the bank’s earnings growth for 2014 already looks to be closer to 6% than the previous year’s 10%.

One thing Commonwealth Bank does have in its favour is that it already holds 11% of its capital in the so called ‘Tier 1’ capital group; 3% higher than the 8% required by law. Commonwealth has held 11% of its capital in this class since before the release of the FY2013 annual report, so analysts who have predicted a slower rate of earnings as a result of holding higher capital may in fact be correct. Commonwealth also adopted much-talked about ‘Basel III’ improved capital monitoring and reporting processes at the beginning of January 2013.

Foolish takeaway

Commonwealth Bank is a secure investment for your money, and it pays good dividends. Earnings growth may be slower in the near future but I think that Commonwealth is trading right on the bullseye of fair value at the moment. I would label it a buy at under $70.

The bank is secure, has few bad loans and is very well positioned to take advantage of an accelerating Australian and global economy (when that occurs). Investors looking for a more aggressive approach to expansion should check out Australia and New Zealand Banking Group (ASX: ANZ).

 

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Motley Fool contributor Sean O’Neill doesn’t own shares in any company listed in this article.

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