As a value investor, I’m always on the lookout for companies that might be undervalued. As such, I’ve recently been taking a closer look at the HSBC (LSE: HSBA) share price. So would I buy?
Shares in this banking giant have come under pressure over the past 12 months. There’s no one apparent reason why this is the case. However, I believe there’s a range of reasons why investors have been selling HSBC.
The two most important, in my opinion, are the bank’s exposure to China and record low-interest rates.
HSBC share price challenges
HSBC’s exposure to China used to be a competitive advantage. The Chinese economy is enormous and growing rapidly. HSBC already generates more than two-thirds of its income in Hong Kong, and management has been trying to push the business more towards Asia for the past few years.
But China’s recent actions to suppress democracy in Hong Kong have attracted criticism from policymakers worldwide. Unfortunately, HSBC has been on the wrong side of this argument.
Simultaneously, the bank’s bottom line is under pressure from low interest rates. Any bank’s basic business model is to take deposits from customers and lend this money to borrowers.
The bank’s profit is the difference between the interest rate and pays depositors and charges borrowers. But with interest rates where they are today, lenders can’t charge borrowers enough to make a substantial profit. HSBC’s net interest margin, the difference between the rate it pays depositors and charges borrowers, was just 1.2% in the third quarter of 2020. It was 1.7% in 2018.
These are the main challenges the HSBC share price faces. If the net interest margin continues to decline, profits will continue to fall. What’s more, if relations between China and the West continue to deteriorate, HSBC’s reputation may take a further hit.
On the other hand, I see plenty of opportunities for the group on the horizon. An economic recovery after the pandemic could lead to rising interest rates, which would be great news for the lender’s bottom line.
Also, if relations between China and the West stabilise, HSBC is in a unique position. It’s one of the few lenders with a large presence in both markets. This gives the bank an excellent competitive edge over peers and could help its growth if China’s economy continues to expand.
I’m also attracted to the HSBC share price due to its valuation. At the time of writing, shares in the lender are trading at a price-to-book (P/B) value of 0.7. That’s compared to the long-term average of 1.2. This number suggests shares in HSBC are undervalued, although I think it also reflects the risks facing the bank as outlined above. Still, if investor confidence returns this year, the market could overlook these challenges.
All in all, I think the HSBC share price looks cheap compared to its historical valuation. But this doesn’t mean the stock is undervalued. It’s facing many difficulties, and the lender needs to overcome these challenges. Only time will tell if the group can make the most of the competitive advantage of its international footprint. Still, I would buy the stock for 2021 considering its opportunities.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended HSBC Holdings. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.