Investor sentiment towards HSBC (LSE: HSBC) shares has weakened considerably since the start of 2020. While the bank has outperformed its peers, HSBC shares are still down a third so far this year. This figure excludes dividends.
As investors have priced in the uncertain economic outlook facing the broader financial services industry, they’ve rushed to sell bank shares. But this knee-jerk reaction has turned HSBC shares into an undervalued bargain.
Growing uncertainty
Weak business confidence and low interest rates could combine to limit the earnings growth rate of banks all over the world the medium term. What’s more, regulators have also demanded that banks suspend their dividends.
HSBC has complied, but these actions have upset some investors. It was due to pay a dividend of 35p per share this year. This distribution is now on hold for the foreseeable future.
However, looking ahead, it would appear HSBC shares could be an attractive investment at current levels. As one of the world’s largest banks, HSBC has an impressive competitive advantage over the rest of the sector. The banking group is also one of the largest lenders in China. This makes it one of the few genuinely global financial service companies.
China is already recovering from its coronavirus crisis. As HSBC generates more than two-thirds of its income from the Asian powerhouse, the country’s recovery should support the lender’s bottom line.
HSBC’s balance sheet also suggests the group is in a relatively stable position to overcome the current economic uncertainty. The lender’s fully loaded common equity Tier 1 ratio was 14.7% at the end of 2019. That was 4.3% above the regulatory minimum of 10.4%. For some comparison, at the end of June 2008, the ratio was just 8.8%.
Undervalued HSBC shares
All of the above implies that while HSBC shares could remain unpopular among investors in the near term, the bank’s long-term outlook is bright.
HSBC’s strong balance sheet and global operations should enable it to overcome the current economic uncertainty. That’s especially true compared to other UK-based lenders.
Despite this, HSBC shares now trade at their lowest level since the darkest days of the financial crisis. Indeed, shares in the lender are trading at a price-to-book (P/B) ratio of 0.7. A P/B ratio of less than one implies the market believes a business is worth less than the value of its assets.
So, the stock appears to offer a wide margin of safety at current levels. As such, while the recovery in HSBC shares might not be smooth or swift, the bank appears to offer tremendous potential in the long term.
When the company is allowed to reinstate its dividend, investors buying today could see a dividend yield of 8.6%. That suggests HSBC could deliver an attractive return profile for long-term investors from its current share price.
