Shareholders of Commonwealth Bank of Australia (ASX: CBA) have enjoyed an incredible run over the last three years, in which time they've not only generated market-smashing capital gains but also incredible, fully franked dividends.
However, the stock has been struggling to gain traction more recently and has fallen from an all-time high of $96.69 to today's price of $92.36. While some investors would consider that a great buy, here are five signs that the stock could still be overvalued.
Valuation. The bank's shares are trading for just over 16x forecast earnings for the 2015 financial year which is on par with the average ASX 200 stock. However, it trades on a price-earnings growth (PEG) rate of roughly 2.9x (based on forecasts for the 2015 and 2016 financial years), indicating that it is expensive based on its ability to grow future earnings.
No margin of safety. One way to assess a bank's margin of safety is to measure its price-book (P/B) ratio. Currently, Commonwealth Bank is trading on a P/B ratio of 3.05, making it one of the most expensive bank stocks in the world.
Priced for perfection. To extend on points one and two, as seen above, investors appear to have priced in the best case scenario for the bank and ignored the potential headwinds, such as macro economic risks, the potential of rising bad debts and the likelihood of being forced to retain more capital, which would impact the bank's return on equity.
Recent drop. The stock has steadily declined in value since the Reserve Bank of Australia elected to leave interest rates on hold. This indicates that investors are predominantly attracted to its fully-franked dividend in the event that interest rates fall further, but are seeing little value in the shares themselves.
Iron ore. With the iron ore price having rallied nearly 25% since bottoming out earlier this month, investors have reduced their exposure to the banks and simultaneously bought back into the nation's biggest miners, including BHP Billiton Limited (ASX: BHP), Rio Tinto Limited (ASX: RIO) and Fortescue Metals Group Limited (ASX: FMG).
Although there is still a high element of risk involved with investing in the miners, investors now seem to think they can generate superior returns from the miners than the banks. If the iron ore rally continues, it could be these stocks that drive the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) back above the 6,000 point mark.