Investors' attraction to high-yielding dividend stocks remains as strong as ever before, and for good reason. Interest rates are at a record low of 2.5% and could be headed even lower in the near future, so dividends are a great way to recognise superior investment returns.
Commonwealth Bank of Australia (ASX: CBA) is one such stock that offers a solid dividend yield and continues to attract a lot of attention. It is currently yielding 4.8% fully franked. Grossed up, that's a juicy 6.9% dividend yield, which remains one of the more attractive distributions from any company listed in the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO).
However, when buying shares, investors need to consider a lot more than just the dividend yield. For instance, they need to consider whether the price they would be paying for the stock is reasonable, based on the company's ability to continue expanding earnings in the coming years.
Looking at Commonwealth Bank today, its share price is sitting at $82.28 – just 0.5% below its all-time high. At that price, it is trading on a projected P/E ratio of 15.4 and a Price-Book ratio of 2.94, indicating that investors believe it can continue growing its earnings strongly in the future. Indeed, the bank is expected to report a cash profit in excess of $8.5 billion for FY14, and that could certainly increase in the near term with interest rates remaining low.
On the other hand, those earnings could also come under significant pressure. To begin with, bad debt charges are currently sitting at an all-time low, which means costs are minimised. When interest rates rise however, so will the costs which will make it difficult to continue growing earnings.
Investors also need to consider the bank's ability to maintain its current distribution. The same could also be said for Commonwealth Bank's primary rivals, being Westpac Banking Corp (ASX: WBC), National Australia Bank Ltd (ASX: NAB) and Australia and New Zealand Banking Group (ASX: ANZ). All of these companies are offering an even greater dividend yield to Commonwealth Bank and are trading for a similar premium.
The recent Financial System Inquiry, headed by David Murray, recommended that the big four banks hold as much as $23 billion more capital in reserve, which would impact how much they can return to shareholders. Should the dividends fall, investors may become more reluctant to buy the banks' shares which could see their prices drop considerably.
Buy this high-yielding ASX stock before Commonwealth Bank
Although there is no denying how strong Commonwealth Bank is as a corporation, it is by no means trading at a reasonable price and will struggle to deliver market-beating returns in the long run. Before buying shares in Commonwealth Bank, I urge you to consider other alternatives, like the one The Motley Fool's top analyst Scott Phillips recently uncovered.
