Is Commonwealth Bank of Australia a buy at this share price?

Commonwealth Bank of Australia (ASX: CBA) has seen its share price sink 15% since the start of the year when the share price hit a high of over $85.

For shareholders buying in for those lovely fully franked dividends – they certainly got that, but that income has been more than wiped out by the falls in the share price since.

CBA’s share price is now around $72.27, and not far away from its 2016 low of $69.79 reached in April.

There are a number of reasons why CBA’s share price could easily blow through that and sink further.

  • Standard & Poor’s has placed Australia on negative watch which could see us lose our AAA credit rating. The big four banks Australia and New Zealand Banking Group (ASX: ANZ), CBA, National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC) could all face a downgrade to their credit ratings too.
  • The banking regulator, APRA, has made it clear that Australia’s banks will need to hold more capital to maintain a top quartile ranking amongst their global peers – a recommendation coming out of the Financial System Inquiry.
  • Bad debts are rising, and the cycle appears to be turning towards a slow and steady rise in bad debts and higher provisions. That could mean lower earnings and flat or lower dividends to shareholders.
  • Slower economic growth in Australia, not to mention the potential for the property market to head backwards.

But despite all that, CBA currently sports a P/E ratio of 13.5x, below its long term (since 1992) average of 14.5x.

CBA PE Ratio Jul 2016

Source: S&P Global Markets Intelligence

CBA’s price/book ratio currently stands at 2.1x – also below its long term average of 2.2x (since 1992).

There’s just one proviso about those ratios. Australia hasn’t had a recession since 1991/92, so the averages may be skewed more positively than during a normal business cycle. And the longer Australia goes without a recession, the closer we get to the next one.

Foolish takeaway

CBA is often regarded as Australia’s highest quality bank – thanks to its high return on equity, revenue growth and a range of other factors. On that basis, it’s also worth paying more for its shares compared to other banks.

For investors with a long term investing horizon, a fully franked dividend yield of 5.8% also offers some compensation for potential further falls in the share price.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

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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