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Why the Commonwealth Bank of Australia (ASX:CBA) share price could soon drop 10% or more

The biggest constituent of the ASX Index is Commonwealth Bank of Australia (ASX: CBA), so it’s bad news if it drops significantly.

According to analysts at Morgan Stanley and Citi, our biggest bank faces a significant fall if the Royal Commission comes out with judgements that are worse than most people are expecting.

Analysts like to consider a range of possibilities for each business and the most likely outcome determines what a reasonable share price would be. If the market has underestimated the possible consequences then the market could be in for a rude awakening.

The Commonwealth Bank share price has already fallen over 25% since its all-time high in 2015 due to a slowing housing market, additional capital requirements, sluggish mortgage growth and a contracting net interest margin (NIM).

However, Citi believe that the Commonwealth Bank share price could fall another 20% to $57.25 in a worst-case scenario. This is because it is more exposed to mortgage lending, along with Westpac Banking Corp (ASX: WBC), compared to Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd (ASX: NAB).

Morgan Stanley has a $65 price target, but thinks the most likely outcome will only be somewhat negative and lead to a 4% share price fall to just under $69.

However, in general both brokers don’t believe that Commonwealth Bank represents a good opportunity. Commonwealth Bank and its peers face structural and cyclical headwinds that could hamper growth for a number of years. The structural changes could be permanent.

Foolish takeaway

Commonwealth Bank is trading at under 13x FY19’s estimated earnings with a grossed-up dividend yield of 8.7%. I wouldn’t buy at today’s price.

Instead, as a dividend idea I’d much rather buy shares in this top stock which is more defensive and also growing much faster.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of National Australia Bank Limited. 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 Scott Phillips.

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