Commonwealth Bank of Australia (ASX: CBA) has posted a rough couple of months, plunging more than 18% from its all-time high to a low of just $79.19 on Wednesday last week. However, the stock managed to narrowly avoid 'bear market' territory – defined as a drop of 20% or more – and has since risen 4.2% to trade at $82.50.
Recognising this, some investors might conclude that now is the perfect time to buy shares in Australia's largest bank. After all, the bank has generated enormous returns for investors in recent years. With interest rates set to remain low for the foreseeable future, it could continue to do so in the years to come, right?
Indeed, there is every chance that Commonwealth Bank may have bottomed out and that it could charge towards its recent high levels. Heck, it might even go on to breach the $100 per share mark, beating other companies such as Cochlear Limited (ASX: COH) and CSL Limited (ASX: CSL) to the mark.
But at the same time, there are numerous reasons to suggest that won't happen. To begin with, the bank had become overpriced at its higher levels and, in my opinion, still remains an expensive prospect today. At $82.50, the stock not only trades on a ratio of 14.8x forecast earnings, but also a price/book ratio of 2.7x – both of which are well above the bank's long-term average.
Meanwhile, a number of forces that have driven Commonwealth Bank's earnings growth in recent years appear to be running out of steam, and could soon reverse course to weigh earnings down. These factors include bad debt charges; heavy competition; tougher capital restrictions; and slower growth in loans when investors eventually recognise how overinflated the property market has become. That is especially the case in Sydney and, to a lesser extent, Melbourne.
Should you buy?
Investors who purchased shares of Commonwealth Bank in March or April (when they were trading at their peak) have learned an important lesson: the bank's generous dividend yield may not be enough to offset any potential capital losses recognised on the stock should it fall.
Although Commonwealth Bank offers a forecast 5.1% fully franked dividend yield, the stock remains overpriced and should be avoided by long-term, 'Foolish' investors.
