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3 reasons why you should avoid Commonwealth Bank of Australia

Commonwealth Bank of Australia (ASX: CBA) shares have staged a major comeback over the last couple of weeks. Since falling into a so called “technical correction” – whereby a stock’s price drops (or rises) by 10% or more – the shares have jumped 9.4% and are once again trading above the $80 mark.

The recovery has no doubt gotten a lot of investors excited. After all, the bank has been one of the ASX’s best performing stocks in recent years thanks to its solid dividend yield and, with interest rates set to stay low for some time yet, who knows how high the stock could climb.

No matter how much the stock could thrive in the near-term however, it is still not reflective of a good long-term buy. Here are three reasons why…

1. Valuation. An investment in Commonwealth Bank will by no means come cheap with the stock trading on a P/E ratio of 15.2x earnings. While that’s actually marginally below the market’s average P/E ratio (roughly 15.8x), the bank’s P/E Growth ratio is at 2.7x, compared to the market’s average 1.88x. This shows that it is quite an expensive investment considering its limited growth prospects.

2. Limited growth. The banks have enjoyed strong earnings growth in recent years thanks to low interest rates and falling bad debt charges. However, Australia’s big four banks are now facing the prospect of more limited growth, caused by higher bad debt charges (they will rise when interest rates inevitably rise), stricter capital requirements as well as heightened competition levels. This may also impact the bank’s ability to increase dividend payments which could see investors head for the exits en masse.

3. Better alternatives. Aside from anything else, it seems highly unnecessary to invest in an overpriced banking stock (which may or may not climb a little higher in the near term) when there are so many other high-yield dividend stocks with far more compelling, long-term growth prospects.

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

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