The Commonwealth Bank of Australia (ASX: CBA) share price has dropped 6% from 20 September 2024, but it still looks expensive to me.
The CBA share price has gone on an incredible run over the past year, rising by more than 34%.
I want to find investments that can match or beat the market over time. While long-term shareholders have done well out of the business, I’d be wary of buying new CBA shares today.
If investors did want exposure to CBA, it could be a safer move to buy a diversified investment which has a sizeable allocation to CBA shares instead, such as Vanguard Australian Shares Index ETF (ASX: VAS).
There are at least three reasons why the CBA share price looks to me too highly valued.
High price/earnings ratio
One of the easiest ways to value a business is looking at the price/earnings ratio (p/e) ratio, which tells us what multiple of profit the business is trading at.
The higher the P/E ratio goes, the more expensive it seems.
The projection on Commsec, which is an independent prediction, currently shows CBA could generate $6.31 of earnings per share (EPS). While it’s good to see profit growth, $6.31 of EPS isn’t enough to justify the valuation. Therefore, the CBA share price is valued at 21.5x FY25’s estimated earnings.
I’ll compare it to a number of other regular financial years. Commsec data says the average annual p/e ratio for CBA was 16.5 in FY23, 16.8 in FY21, 17.8 in FY20 and 14.8 in FY19. Compared to those other years, CBA shares seem expensive today.
Low earnings growth rate expected
In the FY24 result, the business generated $5.88 of cash EPS.
For a business to trade at an elevated price, I think its (expected) profit growth needs to be high enough to justify paying a higher valuation.
Forecasts on Commsec suggest the CBA EPS could rise between high single digits to 10% in FY25 and FY26. That’s not bad, but due to the size of the business I think it’s somewhat unlikely that it will be able to keep delivering earnings growth at a strong enough over the longer-term to justify CBA’s high price.
Low dividend yield due to the high CBA share price
With the high CBA share price, the dividend yield has been pushed lower. The low yield is a sign to me the bank is overvalued. Investors will be getting a lower dividend return, reducing the potential total returns.
According to Commsec, the business is projected to pay a dividend of $4.95 per share, which would translate into a fully franked dividend yield of 3.6%.
The dividend return is usually important for bank investors, so I wouldn’t want to buy CBA shares right now unless CBA can somehow deliver a lot more earnings growth than expected.
There are plenty of other ASX dividend shares I’d rather buy first.
