Reasons for caution, but CBA stays with strengths

AFTER rising 25 per cent last year, shares in Commonwealth Bank sit well ahead of market expectations. The speed of the rerating has taken even market bulls by surprise.

AFTER rising 25 per cent last year, shares in Commonwealth Bank sit well ahead of market expectations. The speed of the rerating has taken even market bulls by surprise.

Analysts' share price targets for CBA are now lagging the actual share price by the biggest differential in more than a decade.

According to data provider Capital IQ, the average analyst share price target for CBA is $54.91, more than 11 per cent below the current $62.20 share price.

According to the bank only one analyst maintains a buy recommendation on the stock. This compares to three analysts who have neutral recommendations and seven that have underperform or sell recommendations on the stock.

Not that CBA is particularly concerned. The bank seems to take the view that if all analysts had buy recommendations on the stock it would probably be because the share price had underperformed due to some calamity and that wouldn't be a good thing for shareholders.

On back-of-envelope valuation measures, such as price to book or price to tangible assets, CBA has always looked expensive.

But one of the changes on CBA's share register is the increased presence of offshore institutions. While there has not been much of a change in retail ownership of the stock, foreign institutions' representation on the register has risen from about 15 per cent two or three years ago to about 19 per cent. A part of the increase can be attributed to global index funds such as Vanguard and State Street Global Advisors increasing their holdings in the stock as CBA's market capitalisation rose above $100 billion, making it the seventh-largest bank in the world.

Among this list CBA is the only one to trade at more than twice the book value of its assets and the only one that trades at greater than 14 times forward expected earnings. In other words, of the big boys, CBA's banking franchise is the most highly rated in the world given the size of its home market.

It reflects the fact that federal Treasurer Wayne Swan and his predecessor Peter Costello have achieved nothing in their aim of levelling competition in the Australian banking market.

The fact remains that CBA has an iron-clad grip on Australian retail depositors and its franchise is only getting stronger despite the best efforts of the likes of NAB.

The active investors who have driven the share price gains in CBA have been attracted to a prospective yield that still sits about 5.5 per cent. For a highly liquid, significant business franchise operating in a global market where bond rates are not far off zero this remains a significant one-year return.

The less-than-compelling results of the three other major banks in November also triggered some subsequent switching into CBA stock.

CBA can be seen as a bellwether stock for the rest of the Australian financial services sector. Banking stocks like few others offer a (leveraged) window into the health of the economy. Unlike peers, CBA has sizeable wealth management operations, which means more than 10 per cent of its profits are typically generated by life insurance sales flows into managed funds.

CBA reports its first-half results on February 13. The market is expecting it to post low single-digit earnings per share growth for the next few years. So while the share price has been rocketing, the operational backdrop remains subdued.

The market expects CBA to post a first-half profit of about $3.65 billion, implying growth of 2.3 per cent on last year. But the first-half dividend is expected to be up more than 16 per cent to about $1.60.

Reasons for caution are growing. Chief executive Ian Narev is still just a year into the role and there is talk of offshore acquisitions. To be clear, CBA has the best retail banking franchise in Australia but everything has its price.

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