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Can Commonwealth Bank of Australia beat the S&P/ASX 200 from here?

If you’re a shareholder of Commonwealth Bank of Australia (ASX: CBA), you’ll no doubt be upset with its recent performance. Following years of dazzling returns, Australia’s biggest bank has crumbled to its knees with the stock down 10.4% since peaking in July, putting it officially in the “technical correction” zone.

With the stock now trading at just $75.19 investors are starting to wonder whether now is the time to buy…

A closer look at Commonwealth Bank

As value investors, it is our goal to find investments that have a strong capability of beating the benchmark returns, measured by those of the S&P/ASX 200 (INDEXASX: XJO). We do this by identifying high quality companies that are trading at reasonable prices and have decent growth prospects moving forward.

While there is no doubting whether Commonwealth Bank is a high quality corporation, the bank’s lofty valuation is an area of huge concern – even at today’s discounted price. At $75.19, the stock still commands a P/E ratio of 14.2, a PEG ratio of 2.5 and a Price-Book ratio of 2.5. Although its P/E ratio is actually below that of the average ASX 200 company (roughly 15.1x), its future growth potential appears limited. In fact, I wouldn’t be surprised if earnings grew by less than 5% per annum over the coming years, which makes its current valuation still excessive.

Investors also need to consider the strong headwinds facing the industry. One of the biggest risks right now is Australia’s inflated housing market. While Commonwealth Bank controls more than 25% of Australia’s mortgage market, it could be hit extremely hard if cracks begin to appear in the sector. Meanwhile, rising bad debt charges and aggressive competition across the finance sector could also restrict earnings growth.

Can Commonwealth Bank outpace the S&P/ASX 200?

Although Commonwealth Bank might seem like more of a compelling buy at its lower price, value investors should still avoid the lure of this big four bank. While the shares could certainly recover some of their value in the near term, I expect that, from its current price, the stock will still struggle to compete with the broader market in the long-run.

Instead, if you're looking to take advantage of the market's recent dive, I urge you to take a look at a different stock. This ultra-promising ASX stock has just been named by The Motley Fool's top investment advisors as their BEST stock to buy for 2015, and I couldn't agree more with their decision.

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned.

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