Down 11% but yielding 8%+, the HSBC share price looks a bargain to me

HSBC’s share price is down 11% from its 12-month high despite record profits. But it now yields 8%+ and the business looks extremely solid to me.

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HSBC’s (LSE: HSBA) share price has lost 11% from its 1 August 12-month high of £6.61. I’m selling one of my two UK bank holdings, and I think I’ll replace it with this one.

Why do I want two UK banks in my portfolio?

It’s true that net interest margins (NIMs) look set to fall this year, as declining inflation brings interest rates down.

The NIM is the difference between the interest a bank receives on loans and the rate it pays for deposits.

This raises the risk of lower profits for all UK banks. But my decision to buy the stock isn’t founded on the short-term profit outlook.

It’s based instead on my view that the UK financial system has been unduly marked down following the 2016 Brexit vote. Such firms are commonly seen by the markets as proxies of their country’s economic prospects.

In my experience as a former investment bank trader, such valuation anomalies tend to be corrected over time.

A major valuation gap?

More specifically, my analysis of HSBC’s share price threw up something I found very interesting.

On the key price-to-earnings (P/E) stock valuation measurement, HSBC doesn’t appear undervalued against its UK peers.

It trades at 6.3 – the same as the peer group average. This comprises NatWest at 4.9, Barclays also at 6.3, Lloyds at 6.4, and Standard Chartered at 7.4.

Crucially, however, all these UK banks do look undervalued against their European peers, the average P/E of which is 7.5.

Even Credit Bank of Moscow trades on Russia’s primary stock exchange at a P/E of 6.3. It rates just 12th by assets in Russia’s banking hierarchy and was placed under international sanctions on 24 February 2022!

Using the deeper discounted cash flow model incorporating other analysts’ figures and my own indicates HSBC is actually around 58% undervalued. Therefore, a fair value would be around £14.07, compared to the current £5.91.

This doesn’t necessarily mean it will ever reach that level. But it confirms to me that it looks very good value.

How strong is the core business?

In 2023, profit before tax rose by $13.3bn (£10.4bn) to a record $30.3bn, and after tax increased from $8.3bn to $24.6bn.

They would have been higher but for a $3.4bn impairment for potential losses connected to China’s troubled property sector.

HSBC operates as a standalone legal entity in the UK, but like many international banks, it has risk exposure to China.

This said, the country exceeded its 5% economic growth target for 2023, achieving 5.2%. It has also set the same target of “around 5% growth” for this year as well.

Increased dividend and buybacks

HSBC paid a total dividend for 2023 of 61 cents (48p) a share. Based on the current exchange rate and share price of £5.89, this gives a yield of 8.1%.

This is by far the highest of the UK’s ‘Big Four’ banks. It is also one of the few shares in the FTSE 100 that pays above 8%, with the average yield being 3.9%.

An additional bonus for shareholders is a planned $2bn share buyback to be completed by 30 April. These tend to be positive for share prices.

For its yield, share price outlook, and strong core business I intend to add it to my holdings.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

HSBC Holdings is an advertising partner of The Ascent, a Motley Fool company. Simon Watkins has positions in Lloyds Banking Group Plc and NatWest Group Plc. The Motley Fool UK has recommended Barclays Plc, HSBC Holdings, Lloyds Banking Group Plc, and Standard Chartered Plc. 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.

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