Shares in Commonwealth Bank (ASX: CBA) continue to gain despite a slowdown in the economy. This morning, the shares opened at $73.86 (their highest point in history), which values the company at around $119 billion by market capitalisation. This makes Commonwealth by far Australia's biggest single listed stock.
As a good investor, every time you choose to buy or sell a stock you have to be able to objectively evaluate the company's prospects for future growth. That means if you buy Commonwealth's shares today, would you expect them to outperform the market? This Fool thinks the answer is no.
With the RBA likely to cut rates next week, investors are piling into CBA shares in search of yield and safety. This might seem logical, but it's actually counterintuitive because the higher the share price goes, the dividend yield gets smaller and there is more risk of overpricing. In May, we saw overpricing of bank shares take their toll on investors' pockets and CBA dropped 9% — an amount far greater than the dividend it pays for a full year.
With a slowdown looming in the economy, shareholders are hoping to weather the storm of low interest rates and growth by putting money in fully franked bank stocks. However, RBS Morgans senior trader Luke McElwaine says "one of the biggest [sectors] exposed to the economy are the banks because they are exposed to people's jobs and those jobs are exposed to property".
Mr McElwaine is not alone. Credit Suisse equities analyst Damien Boey is concerned that many investors have got an idea that the banks are immune to a weakness in the mining sector. "People see the resources side as getting worse and they think that banks don't have any direct exposure to mining and so therefore, they are relatively defensive".
However, it is the flow on effects of a contraction in mining (and the economy) which take their toll on banks. The job losses from mining, poor employment figures from other sectors and a growing population means that unemployment is expected rise which will put pressure on mortgagees and businesses. Currently, CBA has the biggest share of mortgages in Australia whilst NAB (ASX: NAB) is more exposed to the economy because of its business banking.
An overseas threat
Mr Boey also believes that as interest rates fall, our banks will become less attractive to international investors, such as the Japanese, who invest heavily in Australia for high yields. Particularly as the Japanese market has shown weakness in recent days it is likely many will withdraw funds from Australia to invest back home. Mr Boey said "The last time we saw this sort of weakness in Japan, we saw yield stocks in Australia get smashed because the Japanese are major holders of Australian high-yielding companies."
Foolish takeaway
Commonwealth currently trades on a P/E of 15.5, which is very high considering the growth that awaits it (if any). Investors should show caution before committing to any of the big banks at current prices, even ANZ (ASX: ANZ) is becoming slightly expensive but has the most growth potential.
Instead, investors should be looking for other yield plays outside the big four which pay greater dividends and have better growth prospects. Discover The Motley Fool's favourite income idea for 2013-2014 in our brand-new, FREE research report, including a full investment analysis! Simply click here for your FREE copy of "The Motley Fool's Top Dividend Stock for 2013-2014."
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Motley Fool contributor Owen Raszkiewicz owns shares in ANZ.
