HSBC’s (LSE: HSBA) share price is trading around an all-time high, having risen 56% this year alone. However, this does not mean there is no value left in the stock, as value and price are different.
Value reflects the true worth of the underlying business, while price is whatever the market will pay at any time. In my experience as a former senior investment bank trader, knowing this difference is the key to big long-term profits.
Consequently, I took a deep dive into HSBC’s business and then its share valuation to assess its value proposition.
How does the underlying business look?
The key driver for any stock’s price is earnings growth in the underlying business.
A risk to HSBC’s is the imposition of any new tax on banking profits. This idea was suggested recently by the Institute for Public Policy Research. The UK’s Treasury said it did not comment on speculation over tax policy decisions.
That said, consensus analysts’ forecasts are that HSBC’s earnings will grow by a very robust 9.7% a year to end-2027.
This broadly aligns with its 19 February results, which saw an 8.7% year-on-year rise in earnings per share to $1.25 (£0.92). Profit before tax increased 6.5% year on year to $32.309bn, surpassing analysts’ projections of $31.67bn.
These numbers enabled the bank to enhance its shareholder rewards. These included a 43% increase in the dividend per share to 87 cents and a $2bn share buyback. These actions tend to support share prices, especially the latter.
How does the price-valuation gap look?
The best method I have found to pinpoint the gap between a stock’s price and value is discounted cash flow (DCF) analysis. This identifies where any stock should be trading, based on cash flow forecasts for the underlying business.
In HSBC’s case, the DCF shows its shares are 32% undervalued at their current £10.30 price. Therefore, their fair value is £15.15.
In my experience, asset prices tend to converge to their fair value over time.
Additional shareholder rewards
Shareholders also stand to benefit from ongoing high dividends, according to analysts’ forecasts.
In 2024, HSBC’s 87 cent payout (65p) gives a current dividend yield of 6.3%. By comparison, the FTSE 100’s present average dividend yield is 3.4%, and the FTSE 250’s is 3.3%.
Part of the 2024 payout comprised a 16p equivalent special dividend, which is not guaranteed this year. However, even without it analysts’ forecast rise in this year’s basic dividend to 50.5p (from 49p). The projection for 2026 is 53.5p, and for 2027 it is 58.6p.
These would give respective annual dividend yields on the current share price of 4.9%, 5.2%, and 5.7%.
So another £10,000 investment by me – on the lowest of these yields (4.9%) would make me £6,307 in dividends after 10 years. And after 30 years, this would increase to £33,362. This includes me reinvesting the dividends paid back into the stock over those periods (dividend compounding).
At that point, this £10,000 initial investment would be worth £43,362. And this would pay me £2,125 a year in dividend income by that stage.
So given its strong earnings growth prospects, undervalued share price, and high yield, I will buy more of the stock very soon.
