Stock showdown: Do foreign banks expose CBA’s extreme valuation?

Welcome to Stock Showdown, where we tap insights from Morningstar’s equity research and data to compare the business and investment merits of different companies.

Today’s edition is a little different. We aren’t going to compare two ASX shares. We are going to look at how Commonwealth Bank (CBA) compares to a few domestic and international peers on quality and valuation.

Today’s contenders

I chose to compare CBA to a few banks rather than one. My main reason for doing this was that picking a suitable comp for valuation is hard. Few companies, even those in the same industry, are really similar enough to do that.

This is especially true for banks. Some operate in one country, others in several. Then you have varying skews to retail banking, business banking, investment banking and other profit centres. Not to mention different competitive and regulatory landscapes.

CBA gets almost all of its earnings from Australia and a tiny amount from New Zealand. In a typical year, roughly 55% of these earnings will hail from retail banking and 35% from business banking. Just 10% come from institutional banking and markets. As you know, it also operates in an oligopoly within Australia.

If I was going to compare it to just one other bank, I would want that bank to share most of those attributes with CBA. This would exclude a lot of big names from a serious one-on-one comparison.

The major US banks were out. JP Morgan, Bank of America and even Wells Fargo get a big chunk of their earnings away from retail and run-of-the-mill business banking. The US banking sector is also far less of an oligopoly than Australia’s.

Canada’s banking sector is closer in that regard, but I excluded the big players here because they all get at least 35-40% of their earnings from markets outside of Canada. Again, probably not the fairest of comps if you had to choose one.

As for continental Europe, most banking markets there are fragmented and many of the bigger players are active in several countries. The UK market is rather concentrated and Lloyds Banking Group has similar focus areas as CBA, but I still wasn’t sure.

Overall, I decided to compare CBA to two groups of banks. Group one is the other three Australian majors. Group two is a collection of nine Narrow and Wide Moat rated banks from the US, Canada, continental Europe and the UK.

What is the best way to gauge a bank’s quality?

Our financials analyst Nathan Zaia suggested that I look at return on equity on the performance and quality side.

This shows how much of the bank’s shareholder’s equity (equal to assets minus its borrowings and other liabilities) is being turned into fresh profits. The preference here is for a higher number, and for a consistently high number at that.

Most banks are valued in relation to their book value, so you want the book value to compound year after year. Good and sustained returns on equity are how you do that.

As for what can support excess returns on equity at a bank, the primary moat source in this industry is a funding cost advantage. This will usually be derived from having large customer deposits in lower interest accounts like current accounts.

This money can then be loaned out at higher rates of interest, of which more can be kept as net interest margin than smaller lenders – like Bank of Queensland, for example – who get more of their funds from offering higher rate term deposits.

Moats in banking can also be supported by scale advantages such as being able to fractionalise operating and marketing costs over a bigger base of revenue. Switching costs can also play a role. Moving banks is a pain, especially if you use several services.

Australia’s big four banks have all been awarded Wide Moat ratings by our analyst Nathan Zaia. This means that he is confident they have durable advantages – namely large and cheap deposits, scale and switching costs – that should enable excess returns on equity for two decades or more.

CBA versus its domestic peers

CBA’s average ROE over the past three years has smashed those of the other Big Four banks.

Figure 1: CBA’s returns on equity have outpaced the other Big Four banks. Source: Pitchbook data as of May 28 2025.

CBA’s winning record stretches back a lot further than that. Look at the gap between its ROE and that of its peers in every fiscal year since 2015. CBA’s returns have moved in the same direction as the other majors’ over time, but they have consistently come out on top.

Figure 2: CBA’s returns on equity versus other Big Four banks, 2014-2024. Source: Pitchbook data as of May 28 2025.

When it comes to explaining why, our analyst Nathan says that CommBank’s unmatched low-cost deposit base of over $850 billion has played a role and can be expected to underpin a similar gap going forward.

He also says that CommBank was ahead of the game in terms of investing in technology to make its operations more efficient. However, the other banks might be expected to eventually catch up in this regard.

CBA’s recent returns on equity also stack up favourably against our sample of moated banking majors from other countries. It’s in the top three of the sample below on a three-year average basis, and likely looks even better over a longer period.

Figure 3: CBA’s average annual return on equity 2022-2024 versus global moated bank sample. Source: Pitchbook

A potential problem

CommBank’s quality isn’t really doubted by anyone. It is a fantastic business with a strong competitive position and a history of good management. The potential headwind that has everybody talking, though, is CBA’s valuation. It looks very expensive on traditional valuation metrics such as price to book and price to forward earnings.

On the charts below I have plotted forward price to earnings ratios on the Y-axis and price to tangible book values on the X-axis. The higher up and further to the right you are the chart, the more expensive your stock is on these metrics. Here is how CBA looks on that basis against the other Big Four banks in Australia:

Figure 4: CBA valuation on price-to-tangible-book and forward P/E versus Aussie peers. Source: Pitchbook data as of May 28 2025.

And here is how it looks when you add in the sample of moated developed market banks. I think it’s fair to say that CBA sticks out like a sore thumb in both samples and on both metrics. While NAB, Westpac and ANZ seem to be on the same planet as most foreign moated banks when it comes to valuation, CBA seems to be in another galaxy entirely.

Figure 5: CBA valuation versus other Big Four banks and global moated sample. Source: Pitchbook data as of May 28 2025.

Might CBA deserve a higher valuation?

Playing devil’s advocate, you could pluck out a few reasons why this might be the case.

As we have already seen, CBA probably deserves some kind of valuation premium over the other Aussie majors. It has shown over a very long time period that it can crank out higher returns on equity than them.
As for its global peers, it is hard to have a better competitive or regulatory environment and position than the major banks enjoy in Australia. Does this warrant a premium, plus an extra one for being the country’s best bank?
Compared to other countries, risks in CBA’s mortgage business are buffered by lower loan-to-value ratios and strong lender protections. A 10% home deposit is standard in the UK, for example, as opposed to 20% in Australia.
Australia’s population is ageing but continues to grow. Its economy and housing sector in particular have been very strong in the past, and it is a very wealthy country. Taken together, should there be an Aussie premium?

All of those things may be true to varying degrees, but it still looks hard to justify such a big discrepancy in CBA’s valuation versus other banks. At four times tangible book and over 26 times estimated forward earnings, it trades more like a tech stock.

Are passive flows playing a role? It’s an easy question to ask but a hard one to answer. CommBank’s double-digit weighting in the ASX200 index pushes a meaningful chunk of any index-tracking flow into Australian equities CBA’s way.

That might sound convincing in isolation. But what about JP Morgan? I would imagine that being 1.5% of the S&P 500 would expose you to a lot more passive buying on a global basis. JP’s price to tangible book is high versus history at 2.75, but that’s a long way from 4.3 times.

Does this mean you should sell CBA?

We certainly don’t think that CBA looks like an attractive buy at recent levels. It currently trades at more than twice our analyst Nathan Zaia’s Fair Value estimate. That being said, this doesn’t automatically mean you should sell the stock if you own it.

Longer-term holders would have the capital gains liability to consider. Not to mention reinvestment risk. If those holders put a lot of value on the fully franked income being provided by those shares, there would also be big boots to fill.

Let’s take an individual that bought CBA shares 10 years ago. For 118 CBA shares on May 28 2015, an investor would have forked out $10,040 at a cost of $85.09 per share. Assuming that no dividends were reinvested, the investor would now have received 48% of their cost basis back, plus franking credits.

In fiscal 2025 alone, they would have received $560.50 in dividends and franking credits on top. That is a net yield on cost of 5.5% from their initial outlay or 7.15% grossed up. As we have covered, the investor has already received a lot of that initial outlay back too.

Selling this position for its recent value of $20,507 would incur a taxable gain of $5,233 and a CGT liability of $1,936 at a 37% marginal tax rate. If held in an SMSF, the taxable gain would be $6977 and the tax liability at 15% would be $1046.

To replace $560.50 of income with the $18,571 left outside of super, you’d need a 3.0% fully franked yield or 4.0% grossed up. With the $19,461 left inside an SMSF, you would require a yield of 2.9% or 3.77% grossed up. Neither of those sound unachievable.

If Nathan’s dividend forecast on fellow banking major Westpac is right, for example, it recently offered a roughly 5% forward yield. This could result in higher income if all of the sale proceeds were reinvested. Or the previous level of income could be replicated with significant funds left over.

Of course, a lot of investors have held CBA for longer than the ten year period used in my example. They may face a far bigger capital gains liability if they were to sell. They may also have received an even bigger percentage of their initial outlay back in dividends already. As ever, the cost/benefit scenario for every investor will be different.