Why is the CBA share price so high and will it rise further?

There has been a lot of discussion recently around why the CBA share price is trading at $120 per share. Thus placing it on a PER of >20x earnings and a price to book value in excess of 2.3x?! The common thesis rests on the quality of its earnings, return on equity and the like. 

In our view, this is not correct. CBA is trading at an overpriced level for another very simple reason. And unless you understand what is driving the price, it is not possible to determine whether it is likely to go higher.

What is driving the CBA share price?

So what is driving the CBA share price at present? In the view of the portfolio managers at Katana, the price is being driven by the ever-increasing flows into passive funds such as ETFs (Exchange Traded Funds).

If we look at the following chart from Morningstar, we can see that in the US, passive money surpassed active money in 2023 for the first time in history. This means that more money is now being managed on an index basis, than actively by fund managers trying to outperform an index. In fact, during the 2023 calendar year, US active funds experienced US$257 billion in net outflows vs passive funds which received US$243 billion in net inflows.

In Australia, we don’t have the same level of granular detail. But what is clear is that there has been a paradigm shift. According to Morningstar and Betashares, the net inflows into ETFs (aka passive strategies) were nearly $30 billion combined during 2022 and 2023. This compares to net outflows of approximately $60 billion for unlisted (active strategies) over the same period.

Why is this important?

So why is that impacting the CBA share price? Well put simply, CBA makes up 7.4% of the index. That means that for every $ that goes into an ETF which is based on an ASX index, ~7.4c will go into buying CBA shares. For every $100,000 that goes into ASX-indexed ETFs, ~$7,400 will be directed toward buying CBA shares. Irrespective of the price or valuation that CBA is trading at.

This demand side factor has been further accentuated by the fact that CBA is heavily owned by retail investors, many of whom have a very low-cost base and would have substantial capital gains tax issues were they to ever sell. Not to mention the emotional attachment!

So the CBA price is being driven by the perfect storm of relentless buy-side pressure combined with limited sell-side activity.

In bygone days, passive money was considered ‘dumb money’ as it was invested into an index without any ‘smarts’ or active intervention. Today, the ‘dumb’ money is looking like smart money! Passive flows are becoming self-perpetuating and driving overpriced stocks to even higher valuations.

Will the CBA price keep going?

The conventional thinking has been to focus on CBA’s margins, credit growth or earnings outlook. But in our view, whilst these factors are important, at present the dominant driver is the flow of money into index funds.

To answer the question of which direction the price will move, we need to focus on the mix between passive and active flows. If money continues to flow or indeed accelerates into index funds, then it is hard to see the CBA price falling away.

Based on the trends in the US, we would expect the flows into passive funds to continue. Whilst we see the right conditions for active managers to add genuine alpha, the industry appears to be past the point of inflection. Low-cost index funds will likely secure a greater piece of the pie in the foreseeable future. Notwithstanding the higher valuations, for large index behemoths such as CBA, this is likely to provide an ongoing tailwind.

Will index investing increase over the longer term? That’s a whole other question, which we’ve been analysing for some time. If you’d like us to write on that, leave a note in the comment section, and if we get enough interest we’ll put pen to paper.