Trimming CBA's price guide

The Australian banking industry is in transition and faces some challenges. Stricter regulation, higher capital requirements, increased competition and technological threats put the major banks' profitability under pressure. At the same time, they're facing lower loan growth.

These are themes we've previously highlighted. And, indeed, Commonwealth Bank's weak Q3 update last week pointed that way. Though judging the pace and impact of industry change is never precise (or easy), in such an environment, it's best to incorporate a wider margin of safety. 

High quality, lower value

As such, we're lowering CBA's price guide. Our amended buy price declines to $63 from $70, and our recommended sell price falls to $90.

CBA is the premier retail bank in Australia and deserves a premium valuation to its peers. The revised buy price represents a forward price-earnings ratio of 11.5, on consensus estimates. While that looks low, the multiple increases to the mid-teens when we factor in higher rates for loan provisions (which are currently at historic lows). The buy price also stands at about 1.7 times tangible book value.

Decent returns

A lower price guide doesn't mean members shouldn't include CBA in their portfolios or even buy it in the right circumstances. It's a high-quality business and our preferred bank, but it's unlikely to trade on the cheap. At the current price we're also still closer to buying than selling and those with very low weightings in the banking sector (well below the 10% we recommend as a maximum for conservative investors) might consider taking small bites before we reach $63. For those with higher weightings in the sector – closer to our 20% absolute maximum or our 10% limit for conservative investors – we'd recommend waiting for a wider margin of safety before buying more.

That's the approach we'll be taking in the Intelligent Investor Equity Income Portfolio, which currently has a weighting of 8.3% in the banking sector (comprising 4.8% in CBA and 3.5% in Westpac), compared to over 20% for the ASX 200.

It remains our view, though, that there's no particular need to have exposure to the banking sector, which in many ways just reflects exposure to the overall economy. We're comfortable having no banking exposure in the Intelligent Investor Equity Growth Portfolio.

We'll provide more detail on the factors affecting banks as we continue our series on the sector. HOLD.

Please note our maximum recommended weighting of 20% for the banking sector as a whole, or closer to 10% for more conservative investors or those with other large property exposures.

Note: The Intelligent Investor Equity Income Portfolio owns shares in CBA. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.

Intelligent Investor is loading up the van and going on tour in May, with events in Adelaide, Melbourne, Sydney and Canberra. If you'd like to hear us talk about building a portfolio to weather any storm, book your spot here.