Often when I suggest Commonwealth Bank of Australia (ASX: CBA) shares are overpriced or should be avoided, some investors question my judgement (heck, they might even question my sanity).
And to be perfectly honest, I completely understand their reservations. After all, Australia's largest bank has delivered enormous returns to shareholders over its history. Over the last five years the shares have jumped 85% (107% including dividends), while that figure balloons out to a whopping 965% (1,530% including dividends) since its inception onto the ASX in 1991.
Meanwhile, the bank has also benefited from the low interest rate environment, which has seen a huge increase in lending activity as well as heavily reduced bad debt charges. Add in its juicy, fully franked dividend yield and it might seem like the perfect stock.
You won't find me questioning the high quality nature of the bank, even despite the recent controversy surrounding its financial planning arm.
But its excessive valuation does concern me greatly.
The stock has fallen marginally in price over the last week since it went ex-dividend and is now trading at $80.27. At that price, it maintains a lofty price-earnings ratio of 15x and a price-book ratio of 2.66x. Not only is it more expensive than any of the other big four banks, namely Westpac Banking Corp (ASX: WBC), National Australia Bank Ltd (ASX: NAB) and Australia and New Zealand Banking Group (ASX: ANZ), but it is also the most expensive bank stock in the world by almost every measure.
While the stock has continued to climb higher and higher over the coming years, I fear that investors are paying too much attention to its enormous dividend yield and not enough to the dangers facing the stock.
The biggest concerns
Based on the lofty valuation, it seems that investors believe the bank can continue to grow earnings strongly over the coming years. In the bank's recent earnings report however, it became obvious that increased levels of competition are acting as a strain on margins, while bad debt charges also rose in the most recent quarter.
Add in the fact the banks will likely be required to hold more capital in reserve to buffer against a market downturn and earnings could really take a hit. And I'm by no means not the only one concerned. David Murray, who is heading the Financial System Inquiry, warned that there was potential for a large correction at some point in the future. Given their inflated valuations, the banks would likely be amongst the hardest hit.
A better bet than Commonwealth Bank
Given its solid yield, impressive returns and 'defensive' nature, Commonwealth Bank is no doubt the pillar of many portfolios. And I couldn't be happier for investors who have bought the shares at some stage over the last 20 years and held on to reap the rewards. But now, I strongly believe the shares have become far too expensive and could be in for a real shock in the not-too-distant future.
