Is CBA overvalued?

Throughout the year, the most common question I was asked while visiting clients across Australia was, "who will win the US election?".

Whilst the impact of a Trump presidency is still a hot topic post-election, the thorny issue of bank valuations has now taken the mantle of most frequently asked question, particularly that of Commonwealth Bank (ASX: CBA) following another strong rise in November.

In the twelve months to November 30, CBA has generated a total return of 57%, rising 11% in November alone. The reality is, this is not a CBA phenomenon with all the banks rising strongly, including minors such as Bendigo and Adelaide Bank (ASX: BEN) which rose 56% over the past year.

• It trades at a price to earnings multiple (P/E) of over 28, a price-to-book (P/B) of 3.5.

• Its cash yield is just shy of 3%, with its gross yield (inclusive of franking credits) just 4.2%. Our numbers indicate the market is trading on a cash yield of 3.6% and a gross yield of 4.8%. I can’t remember CBA trading at less than market yield before. It's now a low yielding bank!

• CBA is trading on nearly twice the P/E of ANZ Group (ASX: ANZ) (14.75x) which has been impacted by a bond trading scandal, and more than twice the P/E of JPMorgan Chase & Co (NYSE: JPM) (13.7x), the biggest and arguably best run bank in the world.

• On a price-to-book ratio, CBA trades at more than double ANZ’s ratio (1.34) and 62% more expensive than JPMorgan’s 2.17. Comyn is a good operator, but is he as good as the legendary Jamie Dimon?

So, we have a bank priced more like a growth stock, than a cash cow. And it's certainly no longer a great yielding stock.

But what does this elevated valuation mean for future returns? 

Well, the reality is not much in the short term. 

Despite being labelled as expensive all year, CBA continues to rise.

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Dr David Allen (portfolio manager of the Plato Global Alpha Fund) recently wrote how value isn’t necessarily predictive of short-term returns, although he was applying the concept to the market itself, not an individual stock.

But I think the same applies to stocks. One just needs to look at the relatively poor track record of value managers. They seem to get it right about one year in five – 2009, 2016 and 2022. 

In the short term, we think factors like quality and sentiment are probably more important than valuation.

Many clients have asked me why has CBA had such a great return over the past year? 

I think there are a number of reasons:

• For a start it's not just a CBA thing, all banks have rallied hard over the year, both here in Australia and overseas. If we think back 18 months, in Australia there was a lot of doom and gloom around the banks. Economists and strategists were calling for interest rates to rise (they have, but not that much), for house prices to fall (they kept rising although have started to come off a little in Sydney and Melbourne), for a mortgage cliff to force a wave of bad debts (it hasn’t, in fact bad debts are at virtually all-time lows) and the possibility of a recession (we haven’t had one, nor has the US).

• I also think share prices in general have factored in future interest rates cuts and lower regulation and corporate taxes under a Trump administration. This is unlikely to impact Australian banks with the exception of Macquarie but has helped sentiment in the banking sector.

• Another telling factor is that despite many market commentators calling the banks expensive, especially CBA, retail investors don’t seem to be selling. Many of my financial planner clients scratch their heads. They tell me trying to get their clients to take profits on CBA is like getting blood from a stone, they just love CBA.

But is it time to buy CBA?

In the longer term, the price you pay for an asset – a house, a bond, a stock – will be more predictive of long-term returns.

So, I am going to go out on a limb here and call CBA expensive for long term investors.

Sure, it’s a high-quality bank, but it's not a growth stock, in fact its cash earnings actually fell in the last financial year and analysts are not predicting much future growth either. 

If you are an investor looking for good yield, perhaps it might be time to take a few profits on CBA and look to invest in higher yielding assets.

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