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Why today’s 7% profit hike confirms my buy rating on HSBC Holdings plc

Shares of banking giant HSBC Holdings (LSE: HSBA) rose by more than 4% this morning, after it reported a 7% rise in adjusted pre-tax profit for the third quarter.

HSBC has risen by nearly 15% since it began a $2.5bn share buyback in August. Despite these gains, it still offers a tempting forecast dividend yield of 6.8%. A high level of exposure to Asia is also a key attraction for many investors, including me.

In this article, I’ll ask whether today’s figures justify my positive view and if the shares still worth buying at current levels?

How good are today’s results?

HSBC’s adjusted pre-tax profit rose by 7% to $5.6bn during the third quarter, thanks to a 4% fall in costs and a 2% increase in revenue, which rose to $12.8bn. The quarterly interim dividend was left unchanged, at $0.10 per share.

Results for the first nine months of the year were broadly as expected. Although adjusted pre-tax profit fell by 6% to $16.7bn compared to last year, HSBC has made $1.3bn of cost savings so far in 2016.

Today’s results suggest that it remains on track to deliver adjusted earnings of $0.57 per share this year. This means that the bank’s expected full-year dividend of $0.50 per share should be covered by earnings, unlike last year.

The big problem

The real problem with banks is that investors aren’t confident in their ability to generate a decent level of profits from their assets. Today’s results from HSBC don’t do much to address these concerns.

Its return on average shareholders’ equity for the first nine months of 2016 was 4.4%, down from 10.7% for the same period last year. The bank’s cost-to-efficiency ratio, a measure of profitability, has risen from 58.8% to 70.2% over the same period. Ideally, this would be below 50%.

Although these nine-month figures are only a short-term snapshot for a bank as large as HSBC, they’re still disappointing.

The good news

While profitability remains below par, today’s results did contain some decidedly good news.

HSBC’s common equity tier one ratio (CET1) rose to 13.9% during the third quarter, up from 12.1% at the end of June. This massive increase is the result of a change in the way part of the bank’s business is viewed by regulators, but it’s still good news. A higher CET1 ratio will reduce pressure on HSBC to accumulate more capital. This could make it easier for the bank to return cash to shareholders through dividends and buybacks.

The other attractive figure that caught my eye today was the loan-to-deposit ratio of 67.9%. This shows that loans only equate to 67.9% of its total deposits. That’s good news, as it means that HSBC isn’t reliant on borrowed money to fund its lending obligations, and will be able to increase lending activity if interest rates rise.

My view

In my opinion, HSBC is playing a sensible game by shrinking and strengthening its operations. This approach should leave the bank well-positioned to expand again in the future, but less vulnerable to a downturn than it was previously.

Although it’s worth remembering that the 6.8% yield has been boosted by the weaker pound, I believe the shares remain a solid buy for long-term income investors.

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Roland Head owns shares of HSBC Holdings. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.