Almost every other day, someone declares Commonwealth Bank of Australia (ASX: CBA) shares are overvalued. To be fair, this is not completely unreasonable, considering the Aussie bank trades on a price-to-earnings (P/E) ratio of nearly 24 times its FY24 net profits.
Why does 24 times earnings seem expensive? It's a simple matter of comparison. The industry average globally is roughly 10 times earnings. But let's say Australian banks demand some sort of premium for whatever reason… even our own ASX-listed bank barometers don't read as high.
From ANZ Group Holdings Ltd (ASX: ANZ) to Westpac Banking Corp (ASX: WBC), none surpass a 20-times earnings multiple. The CBA share price is about as richly valued as it gets in the world of large-cap banks.
How is it, then, that the black-and-yellow banking beast could still be cheap?
CBA shares have an edge
Anyone with some money can be a lender. Yes, there's regulation — capital buffers and anti-money laundering obligations — creating some entry barrier, but there's very little 'product differentiation'. The business model of a modern bank has existed for hundreds of years.
It might be an oversimplification. However, my point is that banks often compete fiercely on price. Whether it is the interest paid to the depositor or charged to the borrower, banks are bidding against each other to win business.
Usually, the harder a bank fights for business, the smaller its net interest margin (NIM) will be. The latest NIMs for the big four are as follows:
- CBA: 1.99%
- Westpac: 1.92%
- National Australia Bank Ltd (ASX: NAB): 1.72%
- ANZ: 1.56%
As you can see, the Commonwealth Bank boasts the highest NIM of the big four. This is a segue into why I think CBA shares can still be relatively cheap despite its P/E being up in the nosebleeds.
Brand and size.
Commonwealth Bank has built an incredible brand over its 113-year history. Furthermore, being the biggest has its advantages.
Banking is one of those industries where people tend to favour the biggest. When dealing with large sums of money, many view size as security, deciding that their money is safest with CBA. Because of this, some people will knowingly accept poorer yields on their cash or higher borrowing rates.
CBA doesn't need to pay for this benefit. In fact, its scale probably makes its operations cheaper to run than others.
The result… a better bottom line for CBA and greater returns for its shares.
Banking on growth
Of course, brand and scale do little for the valuation if it doesn't translate into growth.
At 24 times earnings, CBA needs to grow at a considerable pace. Fortunately, Australia is an attractive country. I reckon the country will continue to see high immigration levels, creating enormous demand for more houses, and CBA is well-placed to ride the wave.
If CBA can keep winning customers on brand and size rather than its rates, I think there could still be solid returns for the long-term shareholder.
