5 reasons to avoid buying Commonwealth Bank of Australia shares

Commonwealth Bank of Australia (ASX: CBA) has been one of the biggest and most notable casualties so far in 2016.

While its shares have so far fallen almost 6% since the end of 2015, it has acted as one of the key forces behind the collapse of the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) which has suffered its worst start to a year in history.

But while that 6% decline might be tempting for some investors to buy back in – especially considering the share’s 5.2% fully franked dividend yield – there are reasons to believe investors should hold off for a while longer. Here are five of those reasons:

  1. China

The big fear on most investors’ minds right now is how a potential downturn in China could impact Commonwealth Bank. Being Australia’s biggest trade partner, a potential downturn in China could flow into the Australian economy, where anything from consumer confidence to property valuations could be hurt. Given the size of Commonwealth Bank’s mortgage book, it could be hit hard if that were to happen.

Now, I’m not suggesting that such an event will happen, but if it does, you need to ensure your portfolio isn’t overly exposed to the potential side effects.

  1. Australian Dollar

In recent years, the lucrative dividend yields offered by the major banks were targeted by local and foreign investors alike. With interest rates around the globe sitting at record low levels, the dividends offered by our major banks looked particularly compelling, which attracted foreign investment.

Now that the United States has increased its own interest rates however, the case isn’t as compelling for those foreign investors to own our banks. With the Australian dollar expected to continue falling, that could exacerbate the rate at which those investors sell in order to avoid any further foreign exchange losses.

  1. Earnings

Australia’s major banks have enjoyed record earnings results in recent years, driven by the low interest rate environment, growing loan books and low impairment charges. But the sector has become much more competitive which is now impacting profitability (measured by net interest margins), while bad debts are also expected to rise in the not-too-distant future and could hinder further earnings growth. Even at today’s share price, it’s possible that investors have not yet fully taken this into account.

  1. Dividends

If earnings do fall, that could put pressure on the bank’s ability to continue paying such generous dividends. Considering their dividends are some of the major reasons why so many investors hold the bank shares, this situation could impact demand for their shares.

That goes for National Australia Bank Ltd. (ASX: NAB), Australia and New Zealand Banking Group (ASX: ANZ) and Westpac Banking Corp (ASX: WBC) as well.

  1. Regulations

To top it off, the banks are being forced to hold more capital against the loans they write as a safeguard against a potential economic downturn. That’s good for the government and for taxpayers because it lessens the likelihood they’ll have to bail the banks out if conditions turn sour, but it’s not so good for shareholders. Many analysts expect the banks will raise even more capital to appease the regulator’s demands.

Further capital raisings could not only dilute shareholder ownership (and act as a drag on the share prices as a result), it could also impact returns on equity and exacerbate the need for any reductions to their dividend payouts.

Although the major banks have generated magnificent returns for shareholders over the years, there is no certainty they will continue to do so in the future. In my opinion, investors should wait for more attractive prices before making a play for the banks.

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Motley Fool contributor Ryan Newman has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. You can follow Ryan on Twitter @ASXvalueinvest.

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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