Income-hungry investors are still circling Commonwealth Bank of Australia (ASX: CBA) shares as a way to beat the low interest rate environment. Currently, the bank offers a grossed up yield of roughly 7.1%, which compares well to the 3% return offered by most term deposits.
However, with the stock trading within 3.5% of its all-time high, are investors who buy the stock destined for below-par returns?
Valuation
The bank's shares are currently trading for $80.94 with a price-earnings multiple of 15.3 and a price-book ratio of 2.7. Not only does this make it a more expensive option than Westpac Banking Corp (ASX: WBC), National Australia Bank Ltd. (ASX: NAB) and Australia and New Zealand Banking Group (ASX: ANZ), but also one of the most expensive bank stocks in the world.
Of course, the bank does carry the heaviest exposure to Australia's booming housing market, which would have played a key role in its shares skyrocketing 65% since the beginning of 2012.
Growth
The bank recently reported a record-breaking $8.7 billion profit, equating to roughly $5.30 in earnings per share (EPS). That puts it on a P/E ratio of 15.3 which would be considered reasonable for a company with strong growth prospects, but not so much for a blue-chip stock expected to grow earnings at just over 5% over the next two years.
And there are no guarantees its performance will even be that strong! More on that below…
Worrying Signs
Overall, the bank's performance to date has been nothing short of astounding, but there are a few areas of concern which could put downwards pressure on earnings in the coming periods, including…
- Competition. it is becoming clear that competition across the sector is impacting the bank's ability to grow the profits it makes on loans. Its net interest margin remained flat at 2.14% last year
- Bad Debts. Low bad debt charges have been a driving force behind Commonwealth Bank's growing profits, but the bank saw them rise in the most recent quarter.
- Housing Market. As I mentioned above, Commonwealth Bank has benefited to date from its heavy exposure to Australia's housing market, however, this also poses as a huge threat. Should cracks start to appear in the market, Commonwealth Bank will be amongst the hardest hit.
- Capital. It is anticipated each of the big four banks will be required to hold more capital in reserve as a safeguard against an economic downturn. This would heavily impact their returns on equity and would also limit their ability to grow dividends (I hate to think how income-hungry investors would take that news).
