The forward price-to-earnings (P/E) ratio — share price divided by the consensus of analysts’ forecasts for earnings per share (EPS) — is probably the single most popular valuation measure used by investors.
However, it can pay to look beyond the consensus to the spread between the most bullish and bearish EPS forecasts. The table below shows the effect of different spreads on a company with a consensus P/E of 14 (the long-term FTSE 100 average).
| EPS spread | Bull extreme P/E | Consensus P/E | Bear extreme P/E |
|---|---|---|---|
| Narrow 10% (+ and – 5%) | 13.3 | 14.0 | 14.7 |
| Average 40% (+ and – 20%) | 11.7 | 14.0 | 17.5 |
| Wide 100% (+ and – 50%) | 9.3 | 14.0 | 28.0 |
In the case of the narrow spread, you probably wouldn’t be too unhappy if the bear analyst’s EPS forecast panned out, and you found you’d bought on a P/E of 14.7, rather than the consensus 14. But how about if the bear analyst was on the button in the case of the wide spread? Not so happy, I’d imagine!
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HSBC
Today, I’m analysing global banking giant HSBC (LSE: HSBA) (NYSE: HSBC.US), the data for which is summarised in the table below.
| Share price 604p | Forecast EPS | +/- consensus | P/E* |
|---|---|---|---|
| Consensus | 92.3 cents | n/a | 11.0 |
| Bull extreme | 113.0 cents | +22% | 9.0 |
| Bear extreme | 70.1 cents | -24% | 14.5 |
* EPS at current $ to £ exchange rate of 1.68
As you can see, the most bullish EPS forecast is 22% higher than the consensus, while the most bearish is similarly divergent at 24% lower. This 46% spread is just a little wider than that of the average blue-chip company.
In terms of the banking sector specifically, HSBC still has some financial-crisis headaches to work through that are somewhat clouding earnings visibility, but the EPS spread is narrower than for more hungover rivals Lloyds (54%), Barclays (61%) and particularly Royal Bank of Scotland (118%).
In contrast, and for further context, I can tell you that Asia-focused bank Standard Chartered — which avoided the Western meltdown and major business restructurings that continue to make forecasting other banks’ earnings a mite tricky for analysts — is currently showing an EPS spread of 35%.
Getting back to HSBC, and moving on to valuation, the consensus P/E is 11, and we can note that even the most bearish EPS forecast gives a rating only a bit higher than the long-term FTSE 100 average of 14. In addition, HSBC is offering comfortably the highest prospective dividend income of the UK banks at over 5%.
For these reasons, together with HSBC’s heavyweight status and fantastic geographical spread, I reckon the shares are looking attractively priced right now for long-term investors.
