Pinned straw:
I am a Bear on CBA at current prices, so much so that I have been shorting CBA since Nov24. It’s a great business but the price is insane is the why and selling call options is the how. It is going very well so far and would require a price over $207 before I went into the red and over $230 to have a 1% negative impact on my portfolio – so small exposure and unlike GameStop we are not going to see the price move in multiples.
But I do have a Bear case for my Bear position to test.
My over-valued assumption is principally based on historical PE ratios (26.6 Vs 17.7 average over the last 10 years) and the low growth (11% EPS growth in 8 years) of CBA.
While CBA is the best of the big 4 banks, it’s not going to achieve sustainable high single digit annual growth in earnings any time soon (well not in the 6-12mth duration of my positions) which you generally need for a PE of 25+.
So if growth expectations are not what is driving the high PE, what else could? I don’t agree with the dumb ETF or growth in Superannuation balances demand for CBA as a valid answer (these have been building over decades and the very high PE is just a recent occurrence) and interest rates are at the highest rates they have been over the last 8 years, so if anything that should reduce the PE.
I suspect it is in part a flight to safety in uncertain times, it’s probably the saftest bank in the world, with both a strong balance sheet and “to big to fail” put implicit from the government. In addition it’s seen as a good place to park money for US investors who are worried about US$ debasement – the A$ should do well as a commodity based economy with relatively low debt compared to the US and we are raising interest rates while the pressure in the US is to drop them.
But this has it’s limits, which is based on the fundamentals of valuation, at some price it doesn’t fill this objective. I think we are at/beyond that point, however that relies on the key assumption of valuation!
What if historical PE’s are no longer relevant and we need to re-think an appropriate PE for banks?
When I started taking investing seriously a over a decade ago, I found it hard to get my head around the low PE’s banks had compared to other companies with similar earnings growth expectations. I subsequently found out that that it was because of the debt banks have, increasing risk and so lowering the PE investors are willing to pay for them.
Makes sense and you can see it globally in bank valuations, the PE’s are usually 2-5 below the market average. Which makes sense if you think there is a chance the bank could fail, banks fail all the time in the US, it’s only the larger ones we hear about.
BUT – who really believes that the CBA is likely to fail – even in a catastrophic situation (eg GFC).
No one, the government will not let it and print any amount of money to prevent it because it’s too big to fail and the GFC proved it.
The Bears Bear Case
So, the bear case to my bear position is that my valuation assumption is fundamental floored and a PE around 25 for CBA is a rational and appropriate valuation for a safe company providing reliable dividends and very modest growth.
At $173.18, a PE of 26.63 you can expect $5.00 in fully franked dividends, which is worth $7.14 or 4.1%. Add 1-2% growth each year and you are doing better than a bank account, term deposit or government bond – which most view it as safe as.
ANZ, NAB and WBC are also trading on higher PE’s than historically the case, but only 20-30% higher compared to 50% higher for CBA. CBA has always had and for the most part deserved a premium to these, so I expect this is much of the differentiation.
So with sufficient doubt on my thesis I will continue to keep my position very small, but would love to hear others thought on the possibility of changes in valuation fundamentals for banks, CBA in particular.
@Tom73, I like the way you’ve framed this. I’ve been thinking about the same issue from a different angle. I see CBA trading on a valuation that no longer behaves like a bank. I see it behaving like a scarce, fully‑franked income asset in a market with a shortage of safe yield. I see superannuation flows creating permanent demand for large‑cap, low‑volatility income. CBA sits at the top of that list.
I also see the PE expansion as a duration issue rather than a bank issue. When investors lose confidence in the risk‑free rate, they pay a premium for stability. CBA has become a regulated utility in everything except name. Utilities globally trade on price‑to‑earnings multiples in the mid‑20s, so the market is acting consistently.
I still see the valuation as stretched on fundamentals. I also see timing as the real challenge for a short. Valuation alone rarely unwinds a premium without a catalyst. I like your position sizing. I like the clarity of your thesis. I’m interested to see how this plays out.
DISC: don't hold IRL or SM
I think there is potentially a risk in anchoring on past P/E ratios and expecting a mean reversion. I'm not making an argument that Commsec is fairly valued, but neither is residential property, gold or cans of coke in a servo. People will pay for it what they pay for it, and that won't always seem rational. I think @Solvetheriddle tossed around a similar idea in his meeting, that potentially we've crossed some sort of threshold for what "good value" looks like in the share market. Back in the day Ben Graham used to buy companies on a discount to book value, then mid teens was the norm, these days closer to 20-25 is seemingly around par. I'm not saying it won't revert, but it's potentially a whole market trend not just Commsec. Woolworths and Coles look like the may have followed the same trend (mid-teens PE's up to mid 20's) in the last 5-6 years.
https://www.macrotrends.net/2577/sp-500-pe-ratio-price-to-earnings-chart shows the trailing 12 month PE of the S&P500.
I have a decent position in the ETF VAS (ASX200) which ends up being heavily weighted by Commsec, I think it's over valued enough that I've drawn down on that position massively and diversified away from the handful of banks and miners who make up the top 50% of the ASX200, but have not shorted it, so I'm kind of with you, just not enough to go short. (also I suspect I've oversimplified your thesis). That's my 2 cents anyway (and it's only worth about that).
Edit VAS is ASX300 not 200.