Investors and fund managers all around the world aspire to invest like Berkshire Hathaway's chairman Warren Buffett, who has built a solid reputation over the last six decades for buying quality businesses and letting them compound in value over the ultra-long term.
Commonwealth Bank of Australia (ASX: CBA) has been one of Australia's more successful stocks for doing just that. In fact, it has smashed the S&P/ASX 200 Index's (Index: ^AXJO) (ASX: XJO) returns over the last 1, 5 and 10 year periods and has climbed an astonishing 232% over the last decade (including dividends).
However, with the stock now trading at $80.79 – just 2.3% below its record high – the question needs to be asked:
Would the bank be a Buffett-worthy investment?
One of the most precious pieces of advice that Buffett has provided over the years – which saw him buy companies like The Coca-Cola Company, American Express and Gillette – is that: "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price".
Forgetting the recent scandal surrounding the bank's financial planning arm for just a moment, Commonwealth Bank is certainly a quality corporation. With a market capitalisation of $131 billion and a forecast annual cash profit of roughly $8.5 billion this year (not to mention a 4.9% fully franked dividend yield), the bank would almost definitely make the shortlist for Buffett and his right-hand man, Charlie Munger, in terms of class.
However, we also need to remember the other key element from that quote above. "It's far better to buy a wonderful company at a fair price…" While there is no questioning the bank's quality, that in itself is never enough if we're not paying the right price for it. The greatest companies don't always make for the greatest investments, after all.
Commonwealth Bank's shares are said to be "priced for perfection". So are its primary rivals, Westpac Banking Corp (ASX: WBC), Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd. (ASX: NAB). They have each been driven to record or multi-year highs by investors searching for 'defensive' stocks offering solid dividend yields to compensate for the low interest rate environment.
The bank's shares are now trading on a forward P/E ratio of 15.1 and a Price-Book ratio of 2.89, and while earnings are tipped to come under significant pressure in the future, they are certainly no bargain today.
While Buffett is willing to pay up for high-quality companies, he will only do so when he expects to receive market-beating returns in the long-run as a result. Although Commonwealth Bank is a classy company, it is by no means trading at a 'fair price'. Buffett would avoid it, and so should you.
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