ASX 200 bank share review – Commonwealth Bank of Australia (ASX:CBA)

In this article, I will walk you through two common valuations tools which an ASX bank share analyst would use to provide his or her ‘target’ on a company like Commonwealth Bank of Australia (ASX: CBA).

As you can imagine, I’m going to show you the easy version, then provide some further resources and offer potential indicative valuations, using CBA shares as my case study. I think it goes without saying but these valuations are not guaranteed.

Why does anyone invest in CBA shares?

Bank shares like Commonwealth Bank of Australia, ANZ Banking Group (ASX:ANZ) and Macquarie Group Ltd (ASX:MQG) are very popular in Australia because they tend to have a stable dividend history, and often pay franking credits.

While I explain the basics of investing in bank shares in this article, if you’re interested in understanding the value of dividend investing in Australia, consider watching the video from our education team at Rask Australia.

CBA’s PE ratio

The price-earnings ratio, sometimes called the ‘PE’ or ‘PER’, compares a company’s share price (P) to its most recent full-year earnings per share (E). Remember, ‘earnings’ is just another word for profit.

Some extremely successful companies like Amazon or Xero Ltd (ASX: XRO) have gone for many years (a decade or more) and never reported an accounting profit — so the PE ratio wouldn’t have worked. That’s why I think it’s important to dig deeper than just looking at the PE ratio and thinking to yourself ‘if it’s below 10x, I’ll buy it.

Using CBA’s share price today, plus the earnings per share data from its 2019 financial year, I can easily calculate the company’s PE ratio to be 14.2x. This compares to the banking sector average of 11x.

If we reverse the logic, we can take the profits per share (EPS) ($4.91) and multiply it by the ‘mean average’ valuation for CBA. This gives us a ‘sector-adjusted’ share valuation of $55.64.

Free report: Our expert just named 3 growth stocks for 2020

rask invest stocks to buy now

DDM models – what are CBA fully franked dividends’ really worth?

As I explain in the video above using Woolworths Ltd (ASX: WOW) as my case study, a dividend discount model or DDM is the most robust way of valuing companies in the banking sector.

DDMs are some of the oldest valuation models used on Wall Street and in the broking community. A DDM model uses last year’s full-year dividends (e.g. from 2019/2020) or forecast dividends for next year and then assumes the dividends either remain consistent or grow slightly for the forecast period (e.g. 5 years or forever).

We’ll run two scenarios. The first will use last year’s dividends, but keep in mind they are not always a reliable input because dividends are not guaranteed — as bank shareholders have found out in 2020 when many of the banks cut or deferred their payments.

Using my DDM we will assume last year’s dividend payment grows at a consistent rate forever at a yearly rate between 1.5% and 3%. If I use an average risk rate between 9% and 14%, my valuation of CBA shares is $49.

However, in my second scenario and using an ‘adjusted’ dividend payment of $4 per share, the valuation drops to $45. The valuation compares to CBA’s share price of $69.60 — implying an over-valuation.

Buy, Hold or Sell

I think it goes without saying that simple models like these are handy tools for analysing and valuing a bank share like Commonwealth Bank of Australia, but they are not perfectly accurate. In addition to what I’ve presented here, it would be a good idea to study the growth of the loans on the balance sheet, think about the provisions for bad loans (income statement), the bank’s rules for assessing bad loans (accounting notes) and its key sources of capital (wholesale debt markets or customer deposit).

Ultimately, before buying CBA shares for their dividends I’d probably consider a dividend ETF like the Vanguard VHY ETF or even the BetaShares A200 ETF. Both offer franking credits.

Disclosure: at the time of publishing, Owen owns shares of Xero and units in the BetaShares A200 ETF.

From 200+ ETFs in Australia, our top investment analyst has just identified his #1 ETF for 2021 and beyond.

Low fees? Check.

Long-term growth potential? Check.

Regular cash returns? Check!

This ETF makes investing in ETFs "Super-Easy".

Simply click here or enter your email address below to access the full ETF report, ticker code, and step-by-step investment guide. Our expert's #1 ETF report is completely free.

No gimmicks, no payment, no credit card info. Just enter your email address below and we'll send you the report right away.

From 200+ ETFs in Australia, our top investment analyst has just identified his #1 ETF for 2021 and beyond.

Low fees? Check.

Long-term growth potential? Check.

Regular cash returns? Check!

This ETF makes investing in ETFs "Super-Easy".

Simply click here to access the full ETF report, ticker code, and step-by-step investment guide. Our expert's #1 ETF report is completely free.

No gimmicks, no payment, no credit card info. Just click the link below and enter your email address. We'll send you the report right away.

CLICK HERE TO GET THE REPORT

Unsubscribe anytime. Read our TermsFinancial Services GuidePrivacy Policy. We’ll never sell your email address. Our company is Australian owned.

Information warning: The information on this website is published by The Rask Group Pty Ltd (ABN: 36 622 810 995) is limited to factual information or (at most) general financial advice only. That means, the information and advice does not take into account your objectives, financial situation or needs. It is not specific to you, your needs, goals or objectives. Because of that, you should consider if the advice is appropriate to you and your needs, before acting on the information. If you don’t know what your needs are, you should consult a trusted and licensed financial adviser who can provide you with personal financial product advice. In addition, you should obtain and read the product disclosure statement (PDS) before making a decision to acquire a financial product. Please read our Terms and Conditions and Financial Services Guide before using this website. The Rask Group Pty Ltd is a Corporate Authorised Representative (#1280930) of AFSL #383169.

Keep reading:

General Financial Advice warning
The information on this website is general financial advice only. That means, the advice does not take into account your objectives, financial situation or needs. Because of that, you should consider if the advice is appropriate to you and your needs, before acting on the information. In addition, you should obtain and read the product disclosure statement (PDS) before making a decision to acquire a financial product. If you don’t know what your needs are, you should consult a trusted and licensed financial adviser who can provide you with personal financial product advice. Please read our Terms & Conditions and Financial Services Guide before using this website.

© Rask Australia 2020

Join 20,000+ smart investors

Join the Rask Australia mailing and we’ll send you free investment reports, podcasts, expert insights, investing courses, ASX news and lots, lots more. All free. 

Unsubscribe anytime. Read our TermsFinancial Services GuidePrivacy Policy. We’ll never sell your email address. Our company is Australian-owned.

feedback-icon

What can we do better?

Howdy, ASX investor.

I really care about your experience today.

Please, let me know if you have any suggestions we can use to improve our site and help others invest in ETFs. 

Cheers! 

Owen Rask