Does An 8% Yield Make HSBC Holdings plc A Buy Despite Profits Miss?

HSBC Holdings (LSE: HSBA) surprised investors this morning with a fourth-quarter loss of $858m. Market forecasts had suggested that the UK’s largest bank would report a profit of $1.95m for the final three months of 2015.

A poor end to the year meant that pre-tax profits for 2015 were $18.9bn. That’s less than was expected, and just 1% higher than in 2014.

It wasn’t all bad news however. HSBC’s dividend has been increased by 2% to $0.51 per share. That gives a stonking 8% yield, which is still covered 1.3 times by earnings of $0.65 per share.

Is this massive yield a good enough reason to invest, or are today’s results a warning that bigger losses may be on the way in 2016?

Why didn’t profits rise?

Several factors combined to keep a lid on HSBC’s profit growth in 2015.

The biggest of these was a $3.7bn impairment for expected losses on loans and other bad debts last year. This was significantly higher than the $3bn forecasts by analysts. It was also 17% higher than in 2014, when the bank’s bad debt losses totalled $3.2bn.

A second factor was that HSBC spent a total of $2,190m on fines, legal settlements and customer compensation payments last year. Although that’s a reduction from the $2,462m reported in 2014, it’s still a lot. Without these costs, HSBC’s pre-tax profit would have risen by 13% in 2015.

The end result was that HSBC’s return on equity fell to 7.2% last year, from 7.3% in 2014. That’s a long way below the firm’s 10% target.

Still getting stronger

One of the goals of HSBC’s restructuring is to get rid of assets and businesses that have higher costs, or are more risky than average. The bank appears to be succeeding in this department as its CET1 ratio, a regulatory measure of capital strength, rose from 11.1% to 11.9% last year.

Like all of its UK-listed peers, HSBC passed the Bank of England’s latest stress tests in December without requiring any remedial action. HSBC is far from being a basket case, so is now the ideal time for contrarian investors to buy?

Is HSBC a buy?

Like most if its peers, HSBC has consistently disappointed investors hoping for a return to sustainable growth. The main reasons for this seem to be misconduct charges and limited growth and poor returns on lending.

This situation probably won’t last forever, but it does suggest to me that HSBC may struggle to hit its target of a 10% return on equity in the next few years.

However, as a long-term income investor, I’m not too concerned by this. HSBC has been in business for 150 years and has weathered many storms before. The shares trade on 8.5 times forecast earnings and at a big discount to book value.

Even if HSBC was forced to cut the dividend by 30%, the shares would still yield 5.6% at today’s price. Capital strength is improving, and last year’s profits were basically flat.

In my view, that’s enough for the shares to rate as a good long-term buy.

Of course, I may be wrong. Big Banks are very hard to analyse. Things could get much worse.

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Roland Head 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.