The legendary investor Warren Buffett once said that 'only when the tide goes out do you discover who's been swimming naked'. While there are several possible potential applications and interpretations of this pithy remark, I think it applies well to overvalued ASX shares and a stock market crash.
Investor sentiment is a funny thing. It can raise quality companies up to lofty, unjustifiable valuations. As well as cause fundamentally strong companies to trade at a discount to their fair valuation.
In the former scenario, it's usually when a market crash, or at least a correction, occurs that we get to discover what the market truly values a company at, once all the exuberance has bled out of the investing world. Or, as Buffett might say, the tide has gone out.
So today, let's discuss two ASX shares that I personally think are of a high calibre, but could still be classed as overvalued today. As such, I think both are exposed to a potential descent back down to earth once the next inevitable market crash comes along.
2 overvalued ASX shares that could suffer in a stock market crash
REA Group Ltd (ASX: REA)
I think property magnate REA Group is a top-notch share on the ASX. It has been able to maintain the phenomenal dominance of its flagship property listing marketplace realestate.com.au over decades now, routinely fending off competition.
This company has benefitted enormously from the famous (or perhaps infamous, depending on which side of the literal fence you are on) housing boom that the Australian economy has been enjoying for the past few decades.
Its growth metrics have been astonishing, and REA Group now has a myriad of other business ventures under its stewardship.
However, its current share price and valuation have given me some concerns. REA shares today trade with a price-to-earnings (P/E) ratio of 58.8. That's pretty lofty by any stretch of the imagination. This valuation implies that a lot of future growth is already built into this company's share price.
Say the next stock market crash accompanies a recession and results in a downturn of the Australian housing market. Under that scenario, we could well see investors panic and pull the REA share price down considerably. After all, a P/E ratio near 60 does leave a lot of room to move if the markets get skittish.
Commonwealth Bank of Australia (ASX: CBA)
CBA is another ASX share that I think looks a little overvalued today. Just like with REA Group, no one can deny this company's fundamental quality and strength.
CBA is by far the largest bank and lending institution in the country. It has a powerful brand and millions of customers. It also has a rather unique legacy as a former government-owned company.
However, CBA is another company that trades on a pretty generous valuation. Today, it commands a P/E ratio of 17.4. That may look low (especially against REA), but it is very much on the high end when compared to other bank stocks.
To illustrate, let's look at CBA's big four peers in National Australia Bank Ltd (ASX: NAB), Westpac Banking Corp (ASX: WBC), and ANZ Group Holdings Ltd (ASX: ANZ). These banks currently trade with P/E ratios of 12.05, 10.8 and 10.6 respectively.
That goes a long way in explaining why the CBA dividend yield (currently 4.36%) is far lower than these other big four banks. ANZ is today trading with a trailing yield of 7.2%.
Banks are arguably some of the most cyclical stocks on the market. That's thanks to their deep ties to the overall health of the economy. So I wouldn't be surprised if the ASX's most expensive bank takes a deep bath if we do see a stock market crash, given the premium CBA shares are presently at.
