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This P/E Suggests HSBC Holdings plc is a Buy

The FTSE 100 has risen by more than 85% since it hit rock bottom in 2009, and bargains are getting harder to find.

I’m on the hunt for companies that still look cheap, based on their long-term earnings potential. To help me hunt down these bargains, I’m using a special version of the price to earnings ratio called the PE10, which is one of my favourite tools for value investing.

The PE10 compares the current share price with average earnings per share for the last ten years. This lets you see whether a company looks cheap compared to its long-term earnings.

Today, I’m going to take a look at the PE10 of the UK’s largest bank, HSBC Holdings (LSE: HSBA) (NYSE: HBC.US).

Strong track record

HSBC’s global focus and strong balance sheet meant that it survived the financial crisis more successfully than any other London-listed bank, except Asian specialist Standard Chartered.

As a result, HSBC’s share price remains broadly in-line with pre-2008 levels, and it offers an attractive and sector-leading yield of 4.1%.

Given that future earnings expectations for banks may be lower than they were before 2008, does this leave HSBC looking expensive?

  Trailing
12-month P/E
PE10
HSBC Holdings 13.4 11.6

My analysis of HSBC’s reported earnings from the last ten years shows that its current 710p share price is equivalent to 11.6 times HSBC’s average earnings from the last ten years.

In contrast, HSBC trades on 13.4 times its earnings from the last twelve months. The bank’s PE10 is made lower because of the four years of record earnings it delivered from 2004-2007.

I’m still buying HSBC

In 2007, HSBC’s earnings per share peaked at $1.69. In comparison, the bank has reported earnings of $0.83 per share for the last twelve months.

To regain these previous earnings highs, HSBC’s earnings per share would have to double from current levels. Although I expect HSBC to deliver meaningful growth over the next few years, I don’t expect it to be able to repeat its pre-2008 performance for the foreseeable future. In my view, HSBC’s PE10 presents a slightly too favourable picture of its current valuation.

Despite this, I continue to rate HSBC as a buy. Its P/E of 13.3 is below that of the FTSE 100, and looks attractive against its riskier UK rivals. What’s more, HSBC’s prospective yield of 4.8% is backed by a very strong balance sheet, making it a strong contender for income portfolios.

Can you beat the market?

If you already own shares in HSBC, then I’d strongly recommend that you take a look at this special Motley Fool report. Newly updated for 2013, it contains details of top UK fund manager Neil Woodford’s eight largest income holdings.

Mr. Woodford’s track record is impressive: if you’d invested £10,000 into his High Income fund in 1988, it would have been worth £193,000 at the end of 2012 — a 1,830% increase!

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> Roland owns shares in HSBC Holdings but does not own shares in any of the other companies mentioned in this article.