Where to from here for the Commonwealth Bank share price?

Commonwealth Bank of Australia (ASX: CBA) has generated enormous returns for investors in the form of both capital gains and dividends since it went public in 1991.

Given its historic returns, it has become one of Australia’s most prized shares. It is the centrepiece for self-managed super funds (SMSFs) and portfolios around the country, to the point where it seems some investors believe the bank’s shares are immune to a heavy sell-off in the future.

What those investors may have forgotten, however, is that the country hasn’t endured a recession since 1991 – the same year that Commonwealth Bank hit the share market.

The banks are cyclical beasts. While they can tend to outperform during times of expansion as consumers and businesses take out more loans, they can be hit hard when the economy takes a turn for the worse.

That’s why market regulators such as the Australian Prudential Regulation Authority (APRA) have cracked down on lending standards and capital requirements.

The aim is to ensure the banks are lending only to those who are capable of repaying their debts even if conditions were to worsen, whilst ensuring the banks have enough capital in reserve to survive a downturn.

These crackdowns, together with the major capital raising undertaken by Commonwealth Bank in 2015, are just two of the reasons why Commonwealth Bank’s shares have fallen from their lofty heights from yesteryear.

The shares now trade for around $78 each, down from around $96 last year.

Where to from here?

Right now, Commonwealth Bank boasts a market value of around $133 billion. It yields 5.4%, fully franked.

It trades on a price/book (P/B) ratio of around 2.2x, compared to nearly 3x in March 2015. And it boasts a return on equity (ROE) of around 16.5%, which is significantly higher than the ROEs supported by most big banks around the world.

Given those numbers, and the historic returns generated by the bank, it’s not difficult to see why investors love Commonwealth Bank of Australia so much.

The recent dip in share price is also seen by some investors as a good reason to buy for the long-term. However, it would be dangerous to assume that Commonwealth Bank’s shares are destined to rise higher.

Together with Australia and New Zealand Banking Group (ASX: ANZ), National Australia Bank Ltd. (ASX: NAB) and Westpac Banking Corp (ASX: WBC), Commonwealth Bank is facing strong headwinds.

To begin with, there is the potential for capital raisings in the near future to enhance its capital structure. This could force the bank to dilute shareholder ownership further, thus reducing its sky-high ROE, or else cut back on dividends, which is one of the key attractions to the stock in this low interest rate environment.

What’s more, Commonwealth Bank has been a key beneficiary of soaring house prices in recent decades, but is also vulnerable if property prices begin to decline. As such, while it might be seen as something of a ‘safe’ investment, it could be hit hard in the event of an economic downturn.

Commonwealth Bank’s shares have certainly become more attractive over the last 12 months thanks to their dip in price. While that may be the case, I still don’t think they’re a screaming buy.

For now, investors looking for exposure to the blue-chips may want to take a look at alternatives such as Wesfarmers Ltd (ASX: WES) or Telstra Corporation Ltd (ASX: TLS). There could well come a time in the near future where Commonwealth Bank is an attractive opportunity, but for now, there are better opportunities.

Investors are likely better off leaving Commonwealth Bank on the shelf and checking out these top-notch blue chip stocks instead.

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Motley Fool contributor Ryan Newman has no position in any stocks mentioned. 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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