3 reasons why CBA will continue to defy bearish expectations

There's a long line of analysts scratching their heads as to why Commonwealth Bank (ASX: CBA) is allowed to trade at around $140 apiece.

The bearish consensus is understandable, given the bank's current valuation:

• A price-to-earnings ratio of 23x compared to its long-term average of around 15x

• CBA is trading at a 45-70% premium to major bank peers, according to Macquarie

• A price-to-book ratio of 3.15. In other words, the company's market cap is trading at more than three times the value of its balance sheet

Most stocks that trade around a 23x multiple are expected to punch out high single-digit to double-digit earnings growth. But in the case of CBA – its earnings fell by around 2% in FY24 and they're widely expected to trend lower in FY25-26.

Given the above, it's extremely hard to say "Hey what a great company, trading at a fantastic price."

#1 Passive Demand

We've all heard about the explosive growth of passive investing and ETFs.

The largest and most popular Aussie ETF is the Vanguard Australian Shares Index ETF (ASX: VAS), which invests in the top 300 stocks on the market. According to Vanguard, the ETF attracted $573 million of inflows over the first half of FY24.

Guess where all that money is going? The ETF's top holdings (as a percentage of net assets and as of 31 July 2024) include:

• Commonwealth Bank 9.27%

• BHP 8.64%

• CSL 6.03%

This means CBA will attract passive inflows (in other words demand for its shares) that help prop up its share price.

CBA holds the top position for several popular ETFs including (plus CBA weight %):

• Vanguard Australian Shares ETF (9.27% as at 31-Jul)

• Vanguard Australian Shares High Yield ETF (10.36% as at 31-Jul)

• iShares MSCI Australia ETF (12.0% as at 14-Aug)

• iShares Core S&P/ASX 200 ETF (9.61% as at 14-Aug)

• Betashares Australia 200 ETF (9.9% as of 15-Aug)

#2 Positive Beta Exposure

One of the reasons why CBA attracts so much passive demand is because it's the largest stock on the ASX and it has a weighting of approximately 10% in the S&P/ASX 200 Index. This forces ETFs and funds to buy the stock.

Beta is a measure of a stock's volatility versus the overall market. By definition, the S&P/ASX 200 has a beta of 1.0, and individual stocks are ranked according to how much they deviate from the market.

Given CBA's sheer size and weighting, it has a beta that's pretty close to 1.0.

Why does this matter? This means you can always justify adding CBA because at worst – You'll perform close to the benchmark.

Many Australian investment funds have underperformed their key benchmark – the S&P/ASX 200 Accumulation Index – due to the lack of exposure to CBA.

CBA price chart vs S&P/ASX 200. Source: Market Index

#3 It's a Solid Company

Valuations aside, CBA's earnings continue to meet market expectations. The business is well-capitalised and has a market share far above that of peers.

While the company's FY24 cash net profit fell 2% to $9.83 billion, this figure was 1% ahead of market expectations. Its net interest margin and full-year dividend were also tracking ahead of consensus.

"We now hold the largest share of stable household deposits in Australia, which have grown over $110 billion since June 2019 and are 65% higher than the nearest peer bank," said CEO Matt Comyn.