The bank’s shares have started the year strongly, so what gives?
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Commonwealth Bank of Australia (ASX: CBA) shares soared in 2024 and the rally has continued into the new year.
The banking stock is up 35% in the past 12 months, having surged more than 3% in the last month alone.
After this roaring rally, some experts are sounding the alarm on CBA shares, noting softer fundamentals and soaring valuations. Let’s dive in and see.
CBA shares a sell, according to this expert
A fundamental investment concept is valuation, which means not overpaying for an asset.
Investors should pay attention to valuations — and that’s exactly what Jed Richards from Shaw and Partners has said about CBA shares.
The investment advisor cited concerns over Commonwealth Bank’s high valuation, according to The Bull.
There’s been a lot of commentary and confusion on CBA’s record share prices during the past year. Broader banking sector management has been quite vocal explaining the expected tough outlook ahead.
Given high interest rates, increasing costs, a flat Australian economy and intensifying private debt competition, we believe the banking sector faces challenges in sustaining recent profits let alone generating growth.
The CBA’s price/earnings ratio [P/E] is much higher than historical levels and is pricing in considerable growth. In our view, this is highly unusual and unlikely given the economic environment.
Shaw and Partners aren’t the only ones sounding the alarm on CBA shares due to valuation concerns.
Firetrail Investments shares this view. In its December shareholder letter, the fund manager said it expected banks to “underperform the market in 2025, but won’t collapse.”
It also expects the valuation multiple on CBA shares to fall sharply “at some point”.
Our preferred metric is price-to-book versus return on equity (ROE). The higher the ROE, the more the market is willing to pay for an asset. If CBA trades back to something more ‘normal’, given its fairly muted ROE outlook, you should expect a 30%+ retracement in the valuation at some point!
As my colleague Seb reported, CBA’s ROE has stagnated at around 14% after falling from 16% in FY16.
Meanwhile, the bank’s price-to-book ratio had surged to more than 3.5x in December, according to Firetrail. This is its highest level in 10 years.
A quick check on CommSec shows that the consensus of analyst estimates rates CBA shares a sell as well.
What about the financials?
The bank’s meteoric rise saw it climb from lows of around $112 in mid-April to close at a high of $161 in December.
CBA also paid $4.65 in dividends per share these past 12 months, up 3% from the previous period.
Despite the market results, its FY24 business results weren’t as impressive. The bank reported flat operating income of $27 billion and a 2% decline in after-tax profit.
However, as my colleague James reported, these results exceeded market expectations, ultimately extending the rally in CBA shares.
With expectations currently as high as ever, I think analysts are right to be sceptical about future returns for CBA shares.
Foolish takeout
While Commonwealth Bank shares have defied the investment laws of physics in the past, experts are treading cautiously about future returns.
The primary concern is valuation and the risk this would pose to an investor buying the stock today.
If these valuation multiples decrease, it would be difficult for the investment result to match the bank’s business result. Time will tell what happens next.
Motley Fool contributor Zach Bristow has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
