Australia's big four banks, Commonwealth Bank, Westpac, ANZ, and NAB, sit among the most consistently profitable financial institutions in the world. They operate in an oligopolistic market, carry strong regulatory backing, and have delivered reliable dividends to shareholders for decades. By almost every measure of financial health, they are exceptional businesses.
The problem is the price. So why are the world's sharpest hedge funds placing record bets against them?
The short answer is that a great business and a great investment are not the same thing. Here is the number that matters. CBA's price to earnings ratio sits at around 26 times earnings, which is 54% above its own 10 year average, and more than double the global banking industry median. The higher it is, the more expensive the stock. CBA is, by that measure, one of the most expensive bank stocks on earth.
The kicker? Over the past three years, CBA's earnings per share grew roughly 1% per year. Its share price grew around 19% per year. The business did not grow that fast. The price just got ahead of itself.
That gap is exactly what hedge funds are targeting. They have now built a record short position of nearly $11 billion against the big four, the largest ever recorded against Australian banks. A short position is essentially a bet that a share price will fall. CBA alone accounts for just over half of that $11 billion, with Westpac second in line.
This is not a bet that the housing market crashes. The logic is quieter than that. Recent federal budget changes are expected to slow housing credit growth, which means the banks grow their loan books more slowly, which means earnings forecasts get trimmed. Slower growth plus an expensive share price is not a good combination.
Part of what kept bank prices elevated for so long was Australia's superannuation sector, $3 trillion of managed money required to track benchmarks heavily weighted toward the big four. Traders now believe those flows are slowing as more funds move toward strategies that react to falling earnings momentum rather than simply buying and holding.
The banks are not broken or failing, simply put, they are overpriced. Watch this space. If the shorts are right and prices correct toward historical multiples, the best run banks in the world might finally be on sale.
"For the investor, a too high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favourable business developments."— Warren Buffett, Berkshire Hathaway Shareholder Letter, 1982
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