Which Bank Shares To Invest In: HSBC?

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 |  About: HSBC Holdings PLC (HSBC)
by: John Kingham

If you're a relatively defensive investor you probably have (or perhaps more accurately, used to have) bank shares near the top of your investment wish list.

They're mostly big, stable companies that have been around for many decades, and even centuries in some cases.

Most of the time they grind out profitable dividends year after year, performing a useful function in society (again, most of the time) and the icing on the cake is the implicit and occasionally explicit government-backed "too big to fail" guarantee.

But since the financial crisis that's all changed.

Many UK-listed banks have suspended their dividends for years, while global and UK regulation of banks has been changed to reduce risks (and therefore returns) and make it easier to allow banks to fail if that's in the best interest of society.

Of the 7 banks listed on the FTSE All-Share index, only 3 have made dividend payments in every year over the last decade.

So much for banks being safe. But they're not all in the same boat and HSBC (NYSE:HSBC) is one of the few to have maintained its dividend.

HSBC - Took a licking but kept on ticking (with a little help from a rights issue)

Maintaining that dividend wasn't easy though. In 2009 HSBC launched and completed Europe's biggest ever rights issue to the tune of £12.9 billion. This diluted existing shareholders by around 30%, unless they paid up to buy the newly issued shares of course.

You can see how the rights issue affected HSBC's financial output in the chart below:

Click to enlarge

Unsurprisingly, the financial crisis and subsequent rights issue hit both earnings and dividends per share. Book value, however, which is shown in absolute rather than per share terms in the chart, grew, largely because of new capital raised in the rights issue.

So the dividend was maintained, but at a reduced level where dividend payments per share are still less than they were a decade ago.

Overall then growth for HSBC has been somewhat lacking, and in fact the way I measure growth suggests that the company has had slightly negative growth in that time.

Of course this also means that the quality or progressiveness of the company's growth is also lacking relative to other large dividend paying companies.

From a fundamental point of view then, HSBC is above average as a bank (largely because it maintained its dividend), but below average as a blue-chip dividend paying company because it has grown more slowly than the FTSE 100.

Its future may be brighter than its past thanks to the emerging market super-cycle

So it doesn't have the most impressive track record in the world, but then again its weak performance through the last decade was almost entirely down to the financial crisis. Without that it's likely that HSBC would have put in a performance that was at least in line with its blue-chip peers.

The question is, will it be able to keep up with the average blue-chip stock in the next decade?

I think a reasonable expectation for a mature company in a mature market like HSBC is growth at or around inflation plus perhaps a percent or two. It's hard to grow when you're already a huge company in a saturated market.

But perhaps there is a glimmer of hope that things may turn out even better than that, all thanks to HSBC's exposure to the world's faster-growing regions.

As a highly diversified, fundamentally international bank (it was originally formed to improve trade between Europe and China), HSBC has a significant footprint in Asia, the Middle East and Latin America.

These are high growth markets fuelled by globalisation, industrialisation and urbanisation (see this super-cycle report (PDF) for an overview).

Although emerging markets are currently out of favour, for the longer-term view I agree with the super-cycle idea. As a consequence my general expectation is that HSBC should see above average rates of growth over the next decade and perhaps longer.

Given that potentially bright future, I would expect HSBC to trade close to and perhaps even slightly above the market's average valuation, but that doesn't seem to be the case.

A 5% yield implies slow growth or dividend cuts ahead, but I think they're unlikely

With HSBC shares currently trading at 600p the dividend yield is a solid 5%. This means that many investors think a dividend cut is likely or, perhaps less drastically, that below average dividend growth is on the cards.

My gut feel is that this view is wrong. I think above average growth of profits and dividends is the most likely outcome, and on that basis I think HSBC is quite attractively priced.

However, as a relatively quantitative investor I would rather go on data than gut feel and on the data side of things my stock screen has HSBC ranked at a respectable 55 out of 246 dividend paying stocks.

The implication is that the shares offer a significantly better balance of growth, quality, yield and value than average.

That's good, but it's not good enough to make me run out and buy the company's shares, but I will definitely be keeping an eye on them.

On the other hand, if I already owned the shares I would be completely happy to hold on to them, collecting dividends and waiting for sentiment to turn upwards once again.