Why HSBC Holdings plc Could Hit 750p In 2016

2015 has been another disappointing year for investors in HSBC (LSE: HSBA), with its shares falling by 16% since the turn of the year. This makes it a hat-trick of poor returns for shareholders in the world’s local bank with its valuation declining by 22% since the start of 2013.

Clearly, 2015’s weakening investor sentiment in HSBC is at least partly due to uncertainty regarding the future growth rate of the Chinese economy. However, it’s also a result of HSBC being seen as a bloated, relatively inefficient and rather lacklustre operation when compared to a number of its banking peers.

And why does it compare badly to those peers? A number of banks have seen lossmaking periods in recent years. As a result, they’ve been forced to cut costs, boost efficiency and focus on core activities that offer more appealing risk/reward ratios. Arguably HSBC, which stayed profitable throughout the credit crunch, wasn’t forced into the drastic changes that were necessary for rival banks.

As a result of HSBC’s poor share price performance, it now trades on a price to earnings (P/E) ratio of just 9.7. This indicates that there’s significant upward rerating potential on offer. Furthermore, the bank’s shares offer a yield of 6.5% from a dividend that’s very well-covered by profit at 1.6 times. Therefore they hold vast income appeal and are set to deliver an income return of almost 13.5% during the next two years.

Such a low valuation and high yield indicate that HSBC’s share price could soar. In fact, a price of 750p wouldn’t be unreasonable since it would equate to a P/E ratio of 14.3 and a yield of 4.4%. The former figure is roughly in line with that of the wider index, while the latter figure is around 10% higher than the FTSE 100’s yield. As such, HSBC trading 50% higher than its present price level at 750p would indicate fair value rather than a moment to worry about potential downside.

Of course, HSBC’s share price won’t deliver such vast gains overnight, nor will it do so without justification. On the latter point, the bank has huge scope to slash its costs over the medium term. It has already identified $5bn in cost savings that have started to be delivered. In fact, its third quarter costs from the current year were lower than its second quarter costs. Looking ahead, a continued fall in costs could act as a positive catalyst on investor sentiment.

Similarly, an improvement in the outlook for China would also help to push the bank’s share price upwards. Clearly, the world’s second largest economy has very bright prospects for growth since it’s transitioning from a capital expenditure-led economy to a consumer-focused economy. As such, demand for credit is likely to increase at a rapid rate and with HSBC being well-positioned to take advantage of this, its long term profitability potential could lead to improved investor sentiment in 2016.

So while the last few years have been hugely disappointing for investors in HSBC, the bank has a highly desirable yield, exceptionally low valuation and the potential for improved investor sentiment next year. Now seems to be the perfect time to buy a slice of it.

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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.