Should You Buy HSBC Holdings plc After Tax Avoidance Allegations?

HSBC (LSE: HSBA) (NYSE: HSBC.US) is in the headlines today after allegations that the bank has helped customers to avoid taxes. They centre on the bank’s Swiss operations and have apparently included the subsidiary allowing clients to withdraw ‘bricks’ of cash in foreign currencies that could, therefore, not be used in Switzerland, colluding to conceal accounts that had not been declared to tax authorities, and also marketing schemes that allowed clients to avoid taxes.

In response to the allegations, HSBC has stated that its Swiss subsidiary, acquired in 1999, had not been fully integrated into the wider group. This allowed levels of compliance to fall short of those expected at HSBC, although it has undergone a ‘radical transformation’ in recent years, according to the bank.

Weaker Sentiment?

Despite the above allegations, shares in HSBC are only 2% down today in a weak market. Of course, they could lead to further investigation and, subsequently, a fine, but HSBC’s share price already includes a very wide margin of safety, and this could be the reason for their modest fall following the negative news flow.

For example, HSBC trades on a price to earnings (P/E) ratio of just 10.8 and, when you consider that the FTSE 100 has a P/E ratio of 15.9, this seems to be unjustifiably cheap. Furthermore, HSBC has an excellent track record of profitability, with it having remained in the black throughout the credit crunch and offering a size and scale that few of its UK peers can match. Therefore, even if there is a fine regarding the allegations that the bank has been failing to do enough to prevent tax avoidance, its share price may not react as negatively as may normally be expected.

Looking Ahead

Clearly, investor sentiment in HSBC could remain weak in the short term, as the market continues to digest the recent news flow. So, buyers of shares in the bank should not expect to make a quick gain. However, there is a significant opportunity to benefit from an upward shift in HSBC’s valuation over the medium to long term, as investors begin to realise that its current rating is simply too low given its bright longer-term prospects.

A prime example of the confidence that HSBC’s management has in its ability to generate brisk profit growth moving forward can be seen in the bank’s dividend growth forecasts. For example, over the next two years it is expected to increase dividends per share at an annualised rate of 8.5%. That’s a very appealing rate of growth and means that the income from a stake in HSBC should easily beat inflation over the next couple of years.

So, while the short term could be tough, and more negative news could come to light, HSBC remains an excellent long-term holding. As a result, now could be a great time to add it to your portfolio and benefit from a potent mix of upward rerating and a growing dividend.

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Peter Stephens 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.