Is it wise to buy CBA shares at their record high?

Commonwealth Bank (ASX: CBA) shares have been unstoppable, up 10% year-to-date and 30% in the past twelve months to record levels.

But at a price to earnings of 22 – you almost never see the bank trade at such an expensive valuation.

Would it be wise to buy Commonwealth Bank at an all-time high and hefty price tag?

The analyst perspective

Almost every major broker has maintained a sell rating for Commonwealth Bank for over a year. This stance has proven to be embarrassing, considering the stock has rallied 30% in the past 12 months.

Market Index's broker consensus page currently has Commonwealth Bank sitting at a 'Strong Sell' and a $90.00 target price.

So how did the stock defy expectations?

"While there have been many narratives around what has driven the banks – i.e. rate cut expectations, regional bank rotation, resources underperformance – ultimately it appears that broadly easing financial conditions have driven the large and liquid ASX banks higher," Citi analysts explained in a note back in April.

A different take

Instead of focusing on analyst perspectives and target prices, I wanted to take a look at CBA's historical performance during periods of expensive valuations.

Since 2004, CBA has traded at an average price-to-earnings of 15.11.

(Note: Data is calculated on a weekly basis and uses trailing price-to-earnings)

CBA chart (top) and CBA price-to-earnings ratio (bottom) | Source: TradingView

What would the forward returns look like if I bought CBA during 'expensive periods'? Here, I define 'expensive' as a price-to-earnings ratio above 17.5 or one standard deviation above the average.

To smooth the averages, we consider only the first instance in each month where the PE ratio exceeds 17.5.

Source: Market Index

What does the historical data tell us?

In a nutshell: Short term returns are pretty poor and negative a slight majority of the time. Returns begin to improve and swing into positive territory over the medium term.

The data set does have its limitations.

• CBA has only traded above a price-to-earnings of 17.5 on a few occasions. Most of the data has come from the following years – 2007, 2010, 2019 and 2021-23

• The returns during 2007, 2010 and 2019 were largely negative, for 2021 it was relatively mixed and 2022-23 was largely positive

What happens now?

Valuations can come down one of two ways – a lower share price or higher earnings. But Citi says, "it is very difficult to construct an earnings scenario which justifies the run in the shares."

The latest financial models from Goldman Sachs expect CBA's earnings per share to fall 2.1% in FY24 and another 4.9% in FY25, before rising 27% in FY26. If analysts anticipate no earnings growth over the next three years, how do we justify the current rally and how can it keep going?

At market bottoms, price usually leads earnings by 2-3 quarters, sometimes even longer. We might be at the point in the cycle where valuations run and earnings take the back seat. But we're still missing a few key ingredients, including interest rate cuts and improved liquidity conditions.

But maybe this is what the share price is trying to tell us – that there are better days ahead. And when they come, the analysts will be quick to tweak their models for more growth. Or maybe CBA is just one of the most ignorant stocks out there.