I think the HSBC (LSE: HSBA) The stock price looks cheap relative to the company’s current earning power and potential for growth over the next few years.
Indeed, at the time of writing, the stock is trading at a price/book value (P/B) of 0.8. Any profitable bank should sell at a P/E of 1, at least.
Additionally, the stock is selling at a price/earnings (P/E) multiple of 10. Again, I think that looks cheap relative to the company’s peers and growth outlook.
In addition to these metrics, I’m also excited about the company’s growth potential over the next five to ten years.
As the 2008 financial crisis approached, HSBC was expanding globally. The company was grabbing smaller lenders from Europe to South America as management pursued an aggressive growth strategy.
However, the financial crisis has undermined this approach. The bank suffered billions in losses during the crisis and management had to rethink the lender’s growth plans. Since 2010, the bank has canceled out much of this global growth. It focused on its core markets, primarily the UK and China, and sold non-core divisions.
This strategy is set to continue. The company is investing significant sums in Asia, particularly in Hong Kong and China, where it believes there is the greatest potential for growth over the next decade. Hong Kong is already its biggest market, and it has a substantial footprint and network in the region.
HSBC share price competitive advantage
This should help support growth in the years to come and could be a substantial competitive advantage for the company.
Wealth management is a key growth area for the company. With booming economic growth and growing financial penetration across Asia, this could be an important growth market for the company. It requires much less capital than traditional banking.
Wealth managers only take a percentage of the fees from each transaction rather than risking their own capital. And as HSBC rolls out its international network of wealth managers and financial services, the company stands to generate significant profits from this division.
The company also invests heavily in technology to help reduce costs. Cost reduction initiatives are expected to reduce overall spending by $2 billion in 2022, with further savings likely in 2023. The savings are expected to offset inflationary pressures on rising costs and wages. And the company is also trying to reduce its exposure to risky assets.
Since the financial crisis, it has been trying to reduce its exposure to these assets and is still making progress. The idea is to have a leaner and more sustainable bank with predictable profits.
In the past, HSBC has relied heavily on derivatives to generate profits, which can be incredibly lucrative. However, they can also expose the group to significant losses if the transaction does not work out.
By unwinding these complex derivatives, the lender will also free up more capital to invest in projects such as wealth management and traditional lending. It is also likely that there will be more cash available for distribution to shareholders.
Indeed, thanks to this initiative, and recent earnings growth, the company announced in its 2021 annual results that its equity ratio at the end of the year was around 14%. This is significantly above the minimum required for the bank and regulators.
The cash returns of the share price
Given these figures, HSBC announced an annual dividend of $0.25 per share (18.9 pence). The company also intends to initiate a new share buyback of up to $1 billion, which will begin after the existing buyback of up to $2 billion ends.
City analysts expect this trend to continue. As the company continues its plans to unwind complex derivatives, reduce costs and improve profitability, it expects a substantial increase in profitability over the next two years.
That’s not counting the benefits the bank will derive from higher interest rates around the world.
Based on current targets, analysts estimate the lender will increase its dividend by 51% in 2022. A further increase of nearly 30% has been forecast for 2023.
Based on these projections, the stock could return 5.1% in 2023. However, I must caution that these are only projections.
There can be no assurance that the business will achieve this performance target. There is also no guarantee that the company will experience significant growth in its profits in the years to come. Economic uncertainty could have a huge impact on this global institution.
A reduction in international trade flows could hit the lender, which has traditionally presented itself as the local bank of the world. The crackdown on high net worth individuals in China could also hurt the company’s growth plans in its wealth management business, although the impact on the division has been limited so far.
Still, I’ll be watching this closely as we move forward.
The bottom line
Even after factoring in these risks, I think HSBC’s share price looks cheap relative to its growth potential over the next two years.
With earnings expected to rise and the interest rate environment beginning to improve for the first time since the financial crisis, the bank is enjoying strong tailwinds. In addition to these tailwinds, it has made substantial progress in improving the condition of its balance sheet and reducing its costs.
Management also seems willing to return a lot of money to investors as profits rise. Based on these factors, I would buy the stocks in my portfolio today and take advantage of the current depressed valuation and income potential in the years to come.
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