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Case: Valuing Commonwealth Bank (CBA)

Commonwealth Bank of Australia (CBA, CommBank) is the largest bank on the ASX, reporting cash net profit after tax of approximately A$9.8 billion for the full year ended 30 June 2024. A bank cannot be valued with an enterprise FCFF DCF, because for a lender debt is the raw material of the business rather than mere financing, so net debt, enterprise value and unlevered free cash flow lose their meaning. This case values CBA on the equity side with a dividend discount model, equivalently a residual-income (excess-return) model, discounted at the cost of equity from CAPM. A price-to-book against return on equity cross-check then ties the multiple to economics through the justified relationship, since a bank earning a return on equity above its cost of equity is worth more than book value and one earning below it is worth less.

Why it matters

For a bank, deposits and wholesale funding are not a sideshow to financing the firm, they are the product, so the usual move of valuing the whole enterprise and then subtracting net debt makes no sense. There is no clean line between operating and financing when borrowing is the operation. The honest fix is to go straight to equity. Forecast what the bank can pay its shareholders, or equivalently the profit it earns above a fair charge for the equity it uses, and discount that at the cost of equity. The same idea shows up as a simple rule on the price-to-book multiple. Earn more than your cost of equity and you trade above book, earn less and you trade below it.

Formulas

Justified price-to-book from return on equity

\dfrac{P}{B} = \dfrac{\text{ROE} - g}{r_e - g}

The fair price-to-book rises with the spread of return on equity over the cost of equity. When ROE equals the cost of equity the ratio is one, so a bank trades at book only when it earns exactly its required return.

Residual-income (excess-return) equity value

V_0 = B_0 + \displaystyle\sum_{t=1}^{\infty} \dfrac{(\text{ROE}_t - r_e)\,B_{t-1}}{(1 + r_e)^t}

Equity value equals current book equity plus the present value of residual income, the profit earned above a charge for equity at the cost of equity. It is the direct-to-equity twin of the dividend discount model and is discounted at the cost of equity, never the WACC.

Worked examples

Scenario

Commonwealth Bank reported cash net profit after tax of approximately A$9.8 billion (FY2024). For illustration only, assume a sustainable return on equity of 13 percent, a cost of equity of 10 percent from CAPM, and long-run growth of 3 percent. What justified price-to-book does this imply, and why is an enterprise FCFF DCF the wrong tool here?

Solution

These rate assumptions are illustrative and anchored only to the real cash profit scale of about A$9.8 billion. Apply the justified price-to-book. The ratio is ROE minus g over cost of equity minus g, which is 0.13 minus 0.03 over 0.10 minus 0.03, or 0.10 over 0.07, about 1.43 times book. The bank is worth roughly 1.43 times its book equity because it earns 13 percent on equity against a 10 percent required return, a positive spread that the market capitalises. The same answer falls out of the residual-income model, which adds to book equity the present value of that excess return, and out of a dividend discount model on the payout the bank can sustain. An enterprise FCFF DCF is the wrong tool because a bank funds itself with deposits and wholesale borrowing that are the raw material of lending, so net debt and enterprise value are not meaningful and unlevered free cash flow cannot be defined cleanly. Push the assumed ROE below the 10 percent cost of equity and the justified ratio falls under one, so the same bank would trade at a discount to book.

NoteEvery figure except the A$9.8 billion cash net profit scale is illustrative and chosen to show the equity-side method, not to state CBA’s actual return on equity, cost of equity, growth or value. The 13 percent return on equity here is a round teaching figure close to but not equal to the reported cash return on equity.

Common mistakes

✗A bank can be valued with an enterprise FCFF DCF. For a lender deposits and wholesale funding are the raw material of the business, so net debt, enterprise value and unlevered free cash flow are not meaningful, and valuation goes straight to equity.
✗Residual income should be discounted at the WACC. The excess-return and dividend discount models live on the equity side, so both are discounted at the cost of equity from CAPM, not the WACC.
✗A bank trading above book must be overvalued. A bank that earns a return on equity above its cost of equity is fairly worth more than book, since the justified price-to-book rises with that positive spread.
✗Price-to-book and the dividend discount model are unrelated checks. The justified price-to-book is derived from the same equity discounting, so a sound price-to-book against return on equity and a dividend discount model should tell a consistent story.

Revision bullets

•Commonwealth Bank (CBA) is the largest ASX bank, cash profit about A$9.8 billion (FY2024)
•A bank cannot use an enterprise FCFF DCF, because funding is its raw material
•Value on the equity side with a dividend discount or residual-income model
•Discount at the cost of equity from CAPM, never the WACC
•Justified price-to-book equals ROE minus g over cost of equity minus g
•ROE above the cost of equity means a bank is worth more than book

Quick check

Why is an enterprise FCFF DCF inappropriate for valuing a bank such as Commonwealth Bank?

Using the justified price-to-book relationship, a bank earning a return on equity above its cost of equity should trade at

Connected topics

Intrinsic Value Cost of Equity (CAPM)Comparable Cos Price-to-Book EV vs Equity

Sources

Commonwealth Bank of Australia (2024)
Commonwealth Bank of Australia. 2024 Full Year Results, Profit Announcement and Annual Report (full year ended 30 June 2024).
Source for the cash net profit after tax scale of approximately A$9.8 billion. All return on equity, cost of equity, growth and price-to-book figures in this case are illustrative.
Titman & Martin on equity valuation
Titman, S., & Martin, J. D. Valuation: The Art and Science of Corporate Investment Decisions. Pearson.
Grounds equity valuation, the dividend discount and residual-income models, and the cost of equity used to discount them.
Damodaran on valuing financial-service firms
Damodaran, A. Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. Wiley.
Explains why banks are valued on equity cash flows rather than firm cash flows, and develops the price-to-book against return on equity relationship.

How to cite this page

Dr. Phil's Quant Lab. (2026). Case: Valuing Commonwealth Bank (CBA). Derivatives Atlas. https://phucnguyenvan.com/concept/sabv-case-cba

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