Commonwealth Bank is Australia's largest retail and business bank, earning 84% of income from net interest on a $1.05 trillion loan book. At A$178 versus fair value A$77, the stock trades 131% above fundamental value. The disconnect reflects passive index flows and retail momentum rather than achievable economics—CBA's 3.55x book multiple requires 22% sustainable return on equity, but regulatory capital constraints cap this at 14%.

Best fit: Quality-focused investors only. CBA represents the highest-quality banking franchise in Australia with peer-leading returns, dominant deposit market share, and a technology platform that delivers measurable competitive advantages. The 7.8/10 moat score reflects genuine structural advantages rather than cyclical positioning. However, quality investors must accept that paying 3.55x book value for any capital-regulated bank eliminates margin of safety entirely—this is a "watch and wait" situation where the business warrants ownership but the price does not.

Commonwealth Bank earns money by borrowing at low cost (deposits) and lending at higher rates (mortgages, business loans). The 26.6% household deposit share—Australia's largest—provides a structural 15-20 basis point margin advantage over competitors. Net interest income of $24 billion represents 84% of revenue, with the remainder from transaction fees, wealth management, and insurance.

First-half 2026 results demonstrated the tension between volume growth and margin pressure. Operating income rose 4% to $15.0 billion as loan book expansion offset net interest margin compression of 2 basis points to 2.04%. Pre-provision profit grew 5% to $8.2 billion, but credit losses of $730 million (7.5 basis points) remained at cyclically benign levels. Business banking delivered standout performance with 11% lending growth and 40 basis points of market share gains to 17.6%.

The investment case centres on quality at an unjustifiable price. CBA's deposit franchise, digital platform leadership ($2.4 billion annual technology investment), and regulatory moat create durable competitive advantages scoring 7.8/10. Management under CEO Matt Comyn has executed flawlessly—simplifying the portfolio, modernising technology, and delivering peer-leading 13.8% return on equity. The problem is mathematical: at 3.55x book value, the market prices a 22% sustainable ROE that regulatory capital constraints make impossible to achieve. Fair value of $77 already embeds generous assumptions—12.25% terminal ROE and 9% cost of equity. At A$178 versus fair value A$77, the stock is overvalued by 131%.

What happened?

First-half 2026 delivered volume-driven growth against margin headwinds. Total operating income of $15.0 billion rose 4% as loan book expansion (interest-earning assets up 9% to $1.26 trillion) more than offset net interest margin compression to 2.04%. The margin declined 2 basis points—broker channel mortgage competition (-2 basis points) partially offset by replicating portfolio benefits (+1 basis point). Pre-provision profit of $8.2 billion grew 5% with the cost-to-income ratio improving to 44.7% from 45.2%. Credit losses remained benign at 7.5 basis points, half the through-cycle expectation of 12-15 basis points. Cash profit of $5.15 billion (up 1%) reflected provision buffer additions.

What's next?

The trajectory splits between above-line strength and below-line normalisation. Pre-provision profit grows 4-5% annually through FY28, driven by 5% loan volume growth (business banking outperforming at 11%) partially offset by net interest margin stabilising at 2.00%. The cost-to-income ratio holds at 44.5-45.0% as technology investment maintains efficiency leadership. Below the line, credit losses normalise from 7.5 basis points toward 12-15 basis points by FY28—the largest earnings headwind, reducing net profit growth by $490 million annually. This normalisation reflects mean reversion from cyclically benign conditions rather than stress. Business banking remains the strongest growth engine, with market share advancing from 17.6% toward 19% over three years. The RBA's February 2026 rate hike confirms that rate cuts remain 12-18 months away, supporting net interest margin near-term but delaying credit quality relief. Return on equity compresses from 13.8% toward 12.5% as credit normalisation takes effect.

What could go wrong?

The extreme valuation premium creates asymmetric downside risk that no fundamental improvement can offset. CBA trades at 3.55x book value versus peer average 1.40x—a 150% premium that requires sustained 22% return on equity to justify. Regulatory capital constraints cap achievable ROE at 14%. Even our most optimistic plausible scenario (13% ROE, 8.5% cost of equity, bull assumptions across all inputs) produces fair value of $104—still 39% below market.

The trigger for re-rating could be passive flow reversal. CBA represents 9% of the ASX200 index weight, meaning index funds mechanically purchase shares regardless of valuation. If market correction or sector rotation redirects these flows, the structural bid supporting the premium disappears. Retail investor concentration (800,000+ direct shareholders, 30% of the register) amplifies sentiment-driven volatility. Peer catch-up in technology capability over 5-7 years would narrow CBA's efficiency advantage, compressing the justified premium from current 150% toward historical 25%. The downside path to $96 (2.0x book—still premium to peers) represents 46% capital loss with no fundamental deterioration required.