I think the HSBC (LSE: HSBA) share price looks cheap compared to the company’s current earnings power and growth potential over the next few years.
Indeed, at the time of writing, the stock is trading at a price-to-book (P/B) value of 0.8. Any profitable bank should be selling at a P/E of 1, at least.
What’s more, the shares are selling at a forward price-to-earnings (P/E) multiple of 10. Once again, I think that looks cheap compared to the corporation’s peers and growth outlook.
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As well as these metrics, I am also excited about the firm’s growth potential over the next five to 10 years.
Improving outlook
In the run-up to the 2008 financial crisis, HSBC was expanding around the world. The firm was snapping up smaller lenders from Europe to South America as management pursued an aggressive growth strategy.
However, the financial crisis put pay to this approach. The bank booked billions in losses during the crisis, and management had to re-think the lender’s growth plans. Since 2010, the bank has been undoing much of this global growth. It has been focusing on its core markets, mainly the UK and China, and selling off non-core divisions.
This strategy is set to continue. The company is investing significant sums in Asia, specifically Hong Kong, and China, where it believes there is the most potential for growth over the next decade. Hong Kong is already its largest market, and it has a substantial footprint and network across the region.
HSBC share price competitive advantage
This should help underpin growth in the years ahead and could be a substantial competitive advantage for the business.
A critical area of growth for the company is wealth management. Thanks to booming economic growth and increasing financial penetration across Asia, this could be a significant growth market for the enterprise. It requires much less capital than the traditional banking business.
Wealth managers only take a percentage of fees of each transaction rather than risking their own capital. And as HSBC deploys its international network of wealth managers and financial nouse, the corporation is likely to generate significant profits from this division.
The company is also investing heavily in technology to help reduce costs. Cost-saving initiatives are expected to reduce overall expenditures by $2bn in 2022, with further savings likely in 2023. The savings are expected to offset inflation pressures on rising costs and wages. And the corporation is also trying to reduce its exposure to risky assets.
Reducing exposure
Since the financial crisis, it has been trying to reduce its exposure to these assets and is still making headway. The idea is to have a leaner, more sustainable bank with predictable profits.
In the past, HSBC has leaned heavily on derivative products to generate profits, which can be incredibly lucrative. However, they can also expose the group to significant losses if the trade 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. There is also likely to be more money available for distribution to shareholders.
Indeed, thanks to this initiative, and recent profit growth, the company announced in its full-year 2021 results that its capital ratio at the end of the year was around 14%. That is significantly above the required minimum for both the bank and regulators.
The share price’s cash returns
Off the back of these numbers, HSBC announced a full-year dividend of $0.25 per share (18.9p). The company also intends to initiate a further share buy-back of up to $1bn, to commence after the existing up-to-$2bn-buy-back has concluded.
City analysts expect this trend to continue. As the company pushes ahead with its plans to unwind complex derivatives, cut costs and improve profitability, they are forecasting a substantial increase in profitability over the next two years.
That is without including the benefit the bank will feel from higher interest rates around the world.
Based on current targets, analysts believe the lender will increase its dividend by 51% in 2022. A further increase of nearly 30% has been pencilled in for 2023.
Based on these projections, the stock could yield 5.1% in 2023. However, I should caution that these are just projections.
Rough projections
There is no guarantee the business will hit this yield target. There is also no guarantee the company will see significant earnings growth in the years ahead. Economic uncertainty could have a huge impact on this global institution.
A reduction in international trade flows could hit the lender, which has traditionally billed itself as the world’s local bank. The clampdown on wealthy individuals in China may also hit the company’s growth plans in its wealth management business, although the impact on the division has been limited, so far.
Nevertheless, I will be keeping a close eye on this as we advance.
The bottom line
Even after taking these risks into account, I think the HSBC share price looks cheap compared to its growth potential over the next couple of years.
With profits set to increase and the interest rate environment beginning to improve for the first time since the financial crisis, the bank has some significant tailwinds. As well as these tailwinds, it has made substantial progress improving the state of its balance sheet and reducing costs.
Management also seems willing to return lots of cash to investors as profits rise. Based on these factors, I would buy the stock from my portfolio today and take advantage of the current depressed valuation and potential for income in the years ahead.
