Commonwealth Bank investors: should I stay or should I go?

Investors question the stock in light of the latest scandal.

As it stands on a dividend yield basis, CBA pays the lowest rate among the big four banks.

Commonwealth Bank is a “bad” company but a very good stock.

The latest scandal — this time money laundering — simply reinforces the vexed reputation of what also happens to be the most important stock in the ASX.

For most investors this new crisis highlights the question of what to do if you hold the stock? And there are few retail investors who don’t.

For the 800,000 direct holders of CBA — which this week posted yet another strong profit report — the issue is all the more stressful because they most likely bought the stock for a lot less than its ­present price of about $80. (The initial float was at $5.)

It is not possible to put a nationwide average “entry price” for CBA’s legion of “mum and dad” investors, but we can safely assume it is less than half of the present price.

And so, if an investor is to sell CBA at any point, capital gains tax is likely to hit hard.

Strictly from an investment perspective, there are two outstanding issues now facing the bank.
● First, how expensive will the scandal become in the immediate term in terms of both the ultimate dollar fine the bank will face in the courts and more broadly what level of distraction will it impose on management.
● Second, will the bank lose its­ ­status as the bellwether for our market, which it inherited from BHP about a decade ago. If it does, the premium investors are willing to pay will drop sharply.

At first glance, this week’s powerful annual result suggests none of these factors present an immediate risk. A 4.9 per cent lift in profit to $9.88 billion was better than ­expected. Crucially from an ­operational basis, income is rising faster than costs.

Moreover, the bank raised the dividend — the single most ­important factor in CBA stock for most retail investors.

The headline issue with CBA is the bank’s excessive exposure to housing, which many believe is at the top of the cycle.

The theory goes that if housing goes off the boil, then CBA will slide with it, but there remains no evidence of any hard landing for housing.

Similarly, there is also the issue of bad debts — or to be precise the remarkable absence of them — as low interest rates mean customers most of the time manage to make their mortgage repayments.

In fact, a significant number of customers are ahead on mortgage repayments. The theory here is that sooner or later bad debts will rise, dragging at bank profits.

But for a long time this has been little more than an academic argument, and for now this issue remains muted.

Crown is slipping

But look a little deeper and there are problems.

On the short-term issue of the scandal, most brokers are pretty relaxed about the scale of any fine that may loom in future, suggesting this monster bank — one of the biggest in the world — will be able to pay it easily.

But it’s worth noting global brokers are much more wary of the potential of court fines to blow out on unsuspecting corporations.

Morgan Stanley says most brokers are using the mechanics behind last year’s Austrac fine of $45 million on Tabcorp to do their numbers, but it warns such comparisons should not be assumed.

Regardless of the size of the ultimate fine from this scandal, in the long term the real issue is whether CBA is fading as the kingpin of the local market — fading not just as the best of the big four banks but as the jewel in the crown of the ASX.

CBA has long been not just our biggest stock but arguably the best of the blue chips — investors have been willing to pay ever higher prices for it on this basis.

More importantly mum and dad investors have been willing to accept relatively lower dividends.

As it stands on a dividend yield basis, CBA pays the lowest rate among the big four banks.

In turn, the exalted status held by CBA stock is based on its “quality”, determined by one big fat number: the return on equity.

CBA became the first leading blue chip to hit an ROE of 20 per cent during the tenure of David Murray and kept that number at this stratospheric level until about 2008.

Under current chief executive Ian Narev the number has been sliding and in the latest results it slid again — this time a full half of 1 per cent to 16 per cent.

Brokers generally forecast ROE will fall further in the months ahead, closing in on 15 per cent, which is broadly the average for the rest of the big four.

And at that point CBA faces a milestone — it’s the point at which is becomes just another bank stock that happens to be very big.

For investors the question is whether these issues are enough to give up on the stock, and the short answer has to be no.

CBA is a profit-making machine — we have yet to sell the full-year numbers of the other banks, but they are unlikely to match the operational numbers or to lift their core numbers such as ROE to CBA’s diminished — yet still impressive — level.

Most brokers (18 of them) have a “hold” on CBA.

For once the hold call may ­actually mean what it says: that for most investors this stock is still too good — and too expensive — to sell.