HSBC (LSE: HSBA) is one of the world’s largest banks, and it’s not surprising its share price trades at a premium to the rest of the UK banking sector. Indeed, at the time of writing, the stock is trading at a forward P/E of 11.2, compared to the UK banking sector average of around 8.
However, despite this premium valuation, I think the HSBC share price still offers excellent value for money. Today, I’m going to explain why I believe shares in the bank have the potential to outperform the FTSE 100 over the next 12-24 months.
Shares in HSBC might look expensive compared to the rest of the UK banking sector, but I don’t think this is a fair comparison.
Domestic banks, such as Lloyds and Royal Bank of Scotland, do almost all of their business in the UK and, as a result, investors have been avoiding these businesses due to concerns about the impact Brexit might have on their operations.
In comparison, HSBC is a global operation and generates the bulk of its profit in international markets, particularly Hong Kong and China (90% of profits come from Asia). As a result, I don’t think it’s unreasonable to say the bank should be valued in comparison to its international peers, rather than domestic UK banks. In the event of a messy Brexit, HSBC’s international businesses will help the company ride out the turbulence.
The international banking sector is valued at around 11 times earnings, which tells me shares in HSBC are not particularly undervalued or overvalued at current levels. If anything, I’d say they’re fairly valued.
With this being the case, I expect the shares to rise steadily over the next two years as earnings per share tick higher.
City analysts pencilled in earnings growth of 1.8% for 2019 and 4.8% for 2020, hardly show-stopping growth. But after factoring in these forecasts, the shares are trading at a 2020 P/E of 10.8, which makes them slightly undervalued, in my opinion.
On this basis, I think the stock could rise by around 3% per annum over the next two years on average as it catches up to growth forecasts.
At the same time, shares in HSBC support a dividend yield of 6.4%. As the payout is covered 1.4 times by earnings per share, this distribution looks exceptionally safe for the time being, and only adds to the investment case.
A dividend yield of 6.4%, plus an average annual capital return of around 3%, implies investors will see an average total return of 9-10% per annum over the next two years.
I can’t guarantee this return, but it looks to me as if there’s a high probability shares in HSBC will produce a high single-digit or low double-digit annual return for investors in the near-term.
As the FTSE 100 has only delivered a total return of 5.8% per annum on average for the past five years, I think it’s safe to say there’s a strong probability the HSBC share price will outperform the FTSE 100 over the next two years.
Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended HSBC Holdings and Lloyds Banking Group. 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.