Should shareholders in HSBC Holdings (LSE: HSBA) and BP (LSE: BP) cut their losses and sell, or increase their stakes in these unpopular stocks?
HSBC Holdings
Shares in Anglo-Asian banking giant HSBC have fallen by 16% over the last six months, as fears of a China slowdown have battered sentiment and triggered a sell-off.
However, unlike the bank’s smaller peer Standard Chartered, HSBC has not shown any signs of distress. Earnings are expected to rise by a respectable 11% this year to $0.80 per share, giving a 2015 forecast P/E of 10.
Market forecasts for HSBC’s earnings have remained almost unchanged over the last three months. At Standard Chartered, they’ve been slashed by almost a third over the same period.
This stable outlook gives me confidence that HSBC’s dividend will be maintained. The expected $0.51 per share payout should be covered 1.6 times by earnings, and gives a prospective yield of 6.4%.
The stronger bank
HSBC’s high dividend yield is backed by a strong balance sheet. The bank’s common equity tier 1 ratio, a key regulatory measure, was 11.6% at the end of June, well above the 10% level considered risky by the market.
One of the most important measures of profitability for banks is return on equity. HSBC reported a return on average shareholders’ equity of 10.6% for the first half of this year, almost twice the sub-standard 5.4% reported by Standard Chartered.
My view is that HSBC is a strong buy for income and value investors. I expect the shares to return to 600p in the medium-term.
BP
Earlier this summer, BP reached an $18.7 billion legal settlement relating to the Gulf of Mexico disaster. Although this seems a lot of money, the payments are to be spread of 18 years.
For a company of BP’s size, paying around $1bn per year in penalties should be quite manageable. More importantly, this settlement removes the uncertainty about BP’s liabilities.
Was it not for the low oil price, I think BP’s July settlement would have triggered a big increase in the firm’s share price. As things stand, I think the current weakness could be a buying opportunity.
Although BP’s current 375p share price puts the stock on a 2016 forecast P/E of 17, I think this is misleading. The oil and gas sector is at a low point in the cycle, but this won’t last forever. The latest reports from OPEC and the International Energy Agency suggest that the oil market will start to rebalance next year, gradually providing some support for oil prices.
BP’s $0.40 per share dividend gives a prospective yield of 6.7%. Although this payout is not expected to be covered by earnings this year, BP’s has a low level of debt and good cash generation. In my view, the firm can and will sustain an uncovered dividend for a couple of years, if necessary.
For long-term shareholders, I suspect now may be a good time to buy more BP and average down.
Of course, BP and HSBC both carry certain risks, thanks to their exposure to the oil and Asian markets.