Commonwealth Bank of Australia (ASX: CBA) shares are too expensive for me to buy in today.
Investing 101
It doesn't matter if we have $1,000 or $1,000,000 to invest, the key challenge is to buy shares for less than they are worth.
It's the same as if we buy a $50 t-shirt from David Jones. Internally, we must believe it is worth more than its price tag of $50.
To determine the 'worth' or value of shares like CBA, analysts use models like discounted cash flow (DCF), dividend discount models (DDM) or ratio analysis (e.g. price-to-book).
However, anyone who has ever run a valuation model will know the final output is — at best — a good rule of thumb and at another extreme — it can completely mislead you.
Models will only add value to the analyst if they take a bigger picture approach of the industry, understand the market, the companies that operate in it and identify the value drivers of the company in question. This 'qualitative' analysis should be 95% of the investing process, in my opinion.
For example, according to The Wall Street Journal, only two analysts out of 16 have a 'buy' rating on CBA shares.
One of them believes CBA shares are worth $93.
At the other extreme, one analyst, who has a 'sell' rating, says it is worth $72 per share.
That's quite a difference!
It is similar to the result you would get if you asked 16 people what the $50 t-shirt is worth.
Some would say $20. Others would say $70.
Ultimately, the only way to know what CBA shares are worth is to understand why it is worth that much.
Is CBA a buy at this share price?
In my opinion, at $84, CBA shares are expensive because:
- The banking sector is cyclical – it rises and falls steeply
- Its shares trade at a premium valuation relative to its peers like National Australia Bank Ltd. (ASX: NAB)
- I doubt it will return to its uber-profitability days of the late 90's (the sector is too competitive)
- Australia is at 'peak debt' in my opinion
- House prices can go higher and lower
Foolish Takeaway
Once you determine what a company's shares are worth, I believe you should aim to buy them at a price that is at least 30% below that level – this is called the 'margin of safety'.
So are CBA shares trading 30% believe their worth?
No way, hose.
