The £119bn market capitalisation of HSBC Holdings (LSE: HSBA) (NYSE: HSBC.US) makes it the second largest company in the FTSE 100, after Royal Dutch Shell.
Both companies offer fat dividend yields and are income favourites, but while Shell’s share price has beaten the index and gained 10% so far this year, HSBC has lagged behind, falling by 5.5%.
Is HSBC’s current weakness is a buying opportunity, or is there worse to come?
Valuation
Let’s start with the basics: how is HSBC valued against its past performance, and the market’s expectations of future performance?
| P/E ratio | Current value |
| P/E using 5-year average adjusted earnings per share | 14.9 |
| 2-year average forecast P/E | 11.2 |
Source: Company reports, consensus forecasts
HSBC’s five-year average P/E of 14.9 is not overly expensive, considering that it includes the 2009 financial year, during which HSBC took a $26bn impairment following one of the worst financial crises in history.
Looking ahead, the market is assigning a very modest forecast P/E of 11.2 to HSBC, despite consensus forecasts suggesting earnings per share growth of 11% in 2014, plus dividend growth of 7%.
In my view, these numbers are simply too good to turn down for income investors: I believe HSBC’s size and financial strength make its 5% prospective yield one of the safest bets in the banking sector, a view shared by star fund manager Neil Woodford, who recently selected HSBC as his first banking investment for ten years.
What about the fundamentals?
HSBC’s valuation looks appealing, but is it backed by strong fundamentals?
| Ratios | HSBC Holdings |
| Common Equity Tier 1 (CET1) ratio | 11.3% |
| Return on equity | 10.7% |
| Growth | Â |
| 5-year dividend growth rate | 7.6% |
| 5-yr book value per share growth rate | 5.6% |
Source: Company reports
The CET1 ratio is the main regulatory measure of financial strength for bank. HSBC’s current CET1 ratio of 11.3% is well above the required level, and has risen steadily from 9.5% in 2012.
This highlights HSBC’s ability to generate capital from surplus earnings, without sacrificing dividend payments, which have risen by an average of 7.6% per year over the last five years — although they are still lower than they were in 2008.
Buy the book
One value I always consider with bank shares is the book value per share. This measure of net asset value is a good way of valuing a banking stock, as bank shares rarely fall below book value, unless the market believes the bank has undisclosed bad assets.
HSBC shares currently trade at 1.1 times book value, an undemanding valuation which provides potential for decent gains, in my view, especially given the rising trend of HSBC’s book value.
Buy HSBC today?
I believe HSBC remains a strong buy for income, based on both fundamentals and valuation.Â