The Commonwealth Bank of Australia (ASX: CBA) share price rose strongly yesterday after revealing a better-than-expected first-half result.
The shares managed to climb around 2.3% on the news and have now gained more than 20% in the space of around three months.
While it appears the market has now fallen back in love with the financial sector since Donald Trump was elected as President, I think investors should be a little more cautious when it comes to buying Australian bank shares in the current environment.
Here are just a few reasons why I think this is the case using the Commonwealth Bank as an example:
Dividend growth has fallen behind inflation
One of the key reasons investors buy bank shares is for their fully-franked dividends. While the CBA has a pretty strong track record of increasing its dividend year after year, it appears dividend growth has flatlined.
As the chart above highlights, CBA's interim dividend has only increased by 0.5% over the last two years. Unfortunately, the short-to-medium term outlook for further dividend increases isn't looking that great either with tighter capital requirements preventing an increase in bank payout ratios.
Bad debts are at historically low rates
Historically low interest rates have provided a fairly nice buffer to borrowers who would have normally defaulted on their loans. However, as the interest rate cycle begins to turn over the medium term, investors should expect these favourable conditions to reverse and the level of loan impairments to increase.
On top of this, low levels of unemployment and a booming housing market have also helped to keep bad debts well under control. Whether these tailwinds can continue is debatable but I think the downside risk is far greater than the upside potential right now.
The CBA share price is not cheap
At around $85 per share, CBA is trading on a price-to-earnings ratio of around 15 and offering a dividend yield of around 5%. While there is no doubt that a fully-franked yield of 5% is far more attractive than what is currently on offer through term deposits, investors must still take into account the potential for capital losses. Importantly, investors who buy shares today will not break-even for the year if the shares fall back to $80.
Foolish takeaway
The banks have been great investments over the long term but I think it is important for investors to think twice before buying bank shares today. In my mind, there is not a large enough margin of safety for investors buying at current prices, especially when you consider the downside risks and the lack of earnings growth on offer over the short-to-medium term.
