Yahoo Finance Is Commonwealth Bank of Australia (ASX:CBA) A Sell At Its Current PE Ratio?
This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between Commonwealth Bank of Australia (ASX:CBA)’s fundamentals and stock market performance.
Commonwealth Bank of Australia (ASX:CBA) trades with a trailing P/E of 12.5x, which is higher than the industry average of 11.8x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Commonwealth Bank of Australia
What you need to know about the P/E ratio
P/E is a popular ratio used for relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for CBA
Price-Earnings Ratio = Price per share ÷ Earnings per share
CBA Price-Earnings Ratio = A$71.91 ÷ A$5.772 = 12.5x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as CBA, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 12.5x, CBA’s P/E is higher than its industry peers (11.8x). This implies that investors are overvaluing each dollar of CBA’s earnings. Therefore, according to this analysis, CBA is an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your CBA shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to CBA, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with CBA, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing CBA to are fairly valued by the market. If this is violated, CBA’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in CBA. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for CBA’s future growth? Take a look at our free research report of analyst consensus for CBA’s outlook.
Past Track Record: Has CBA been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of CBA’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
