Are CBA shares overvalued? Here’s 4 arguments why they are, 4 reasons why they aren’t and our judgement

Are CBA shares overvalued? This is a hotly contested question and arguably the closest thing we’ve had in Australia to the GameStop saga.

While just about all of the 15 analysts covering the company say it is overvalued and have a mean target price of $93.48, a 30% discount, enough investors keep buying and buying to send the company up and up. Yet analysts have not given in after all these months and keep recommending to sell the stock, but are proven wrong. And any thought amongst investors that ‘what comes up must go down’ is clearly in a minority, with just 1.6% of the bank’s equity shorted – a figure that is actually lower than 6 months ago.

As of mid-July 2024, CBA is up 31% in the last year. It is capped at over $200bn, easily one of the top two stocks along with BHP (ASX:BHP).

CBA shares, log scale (Source: TradingView)

Let’s look at both cases to the debate about whether CBA shares are appropriately valued.

Are CBA shares overvalued? 4 reasons why they might be

1. There may not be profit growth for a few years. Consensus estimates expect flat earnings per share in FY24 and FY25 and only slight increases in FY26 and FY27. And this could even be inflated by share buybacks.

2. CBA is way ahead of the other banks on several multiples including P/E (where it is 23x) and P/B (where it is 3.3x). What is there to justify the substantial premium it has over its peers? Yes it is the largest bank, but it is not as if it has a particularly large market share or that significant competitive advantages that it doesn’t need to worry about its peers. L1 Capital recently pointed out that CBA shares were trading at a 60% premium to its peers, compared to the historical average of 17%.

3. Interest rates will come down soon, and this could lead to falling margins. If the bank did not increase its Net Interest Margins so substantially when interest rates rose 13x in a row, how will they go when rates start going down.

4. Technical indicators indicate that CBA is overvalued. One of these is the Relative Strength Index – as of July 17, 2024, the RSI on CBA shares is just over 70, a point nearly 10 percentage points above the 12 month average. The Moving Average Convergence/Divergence (MACD) suggests it is overvalued too, and while it has been suggesting so for months, it is really gettting out of hand.

CBA (ASX:CBA) share price chart, log scale (Source: TradingView)

4 reasons why CBA shares might not be overvalued

1. It is hard to see a realistic scenario that would cause a drop in CBA shares. A severe recession could – even the only pro-CBA analyst (CLSA’s Ed Henning) admitted this. But this is a highly unlikely scenario. A mild recession is possible, but not a severe one. We’ve heard warnings that the interest rate hikes would cause en-masse defaults and this did not happen. Whilst more hikes are likely, it is difficult to see how one or two more could tip the scales in a way that the past 13 have not.

2. CBA makes bumper profits well and ahead of its peers, of over $10bn. No other bank came close, with the rest between $7.2bn and $7.7bn. This is not just because CBA has the most customers and such a big loan book. But the bank has certain advantages over its peers such as its tech stack and lower reliance on mortgage brokers for leads. We don’t think investors should underestimate how important the latter point is. Upfront and trailing commissions eat into a bank’s margin on loans substantially. As a recent note from Macquarie pointed out, no other retail bank has grown its revenues in 5 years.

3. The company pays amongst the highest dividends per share among all stocks. In FY23, 12 million super fund members received a combined $2.4bn in earnings on their CBA shares for FY23. And that does not even account for Australians who hold CBA shares in their own right, outside their super fund. Those people received an average dividend of $3532. We find it hard to imagine it being different in FY24.

4. As Warren Buffet said,’ Price is what you pay value is what you get’. It is easy to look at the bank’s market capitalisation and share price, but it is important to look at all the other factors, those mentioned above and others. One thing we’d add is that the bank is only 23x P/E for FY25. Not dirt cheap by any means, but it is far from the highest – WiseTech is over 80x for example.

So are CBA shares overvalued?

On all the evidence, we think they are not. We think the bank is ‘fairly valued’. Of course the question of how shares are valued, is a different question as to whether or not you should buy the company. While investors wanting dividends won’t be disappointed, we think growth investors have better opportunities elsewhere, particularly in the healthcare, tech and resources spaces – both among large caps and small caps.

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