Over the past year, the performance of the HSBC (LSE: HSBA) share price has been pretty mixed.
Excluding dividends paid to investors, the stock has returned 13.5%. In comparison, the FTSE All-Share Index has returned 11.5%. Including dividends, shares in the Asia-focused bank have produced a total return for investors of 16.9% compared to the index return of 14.8%.
The stock has outperformed the index over the past year, but I think this is discounting its potential. Indeed, the group reported profits for the third quarter of $6bn, an increase of 36% year-on-year.
HSBC share price struggles
On top of this impressive profit performance, the company reported an increase in its common equity Tier 1 ratio, a key measure of balance sheet strength for financial institutions. The ratio ended the quarter at 15.9%, above management’s target rate of 14% to 14.5%.
Management has decided to unleash a $2bn share repurchase programme with so much excess capital on the balance sheet. The buyback will consume 0.24% of HSBC’s Tier 1 capital, leaving plenty of room for additional returns.
There is also plenty of headroom on the balance sheet to maintain the current dividend. At the time of writing, the stock supports a dividend yield of 3.6%.
So, HSBC is a well-funded, growing bank with an international footprint and plenty of scope to return vast amounts of capital to investors over the next couple of years.
As such, it seems strange to me that shares in the company are currently selling at a price-to-book (P/B) value of 0.61. That is compared to its five-year average of 0.8. Its price-to-earnings (P/E) ratio of nine compares to the five-year average of 11.8.
These figures imply the stock is undervalued by between 25% and 50%.
That being said, just because a stock looks undervalued compared to history does not necessarily mean the market will correct this discrepancy.
Growth challenges
There are a couple of challenges the company is having to deal with today. These could explain why investors are not awarding the shares a higher valuation.
HSBC’s exposure to China is the most prominent. The Chinese economy is reeling as the property market enters a downturn, and stricter coronavirus restrictions weigh on economic activity.
This is a concerning scenario for a bank that has staked so much on the region in recent years. A significant increase in loan losses across the region will almost certainly dent HSBC’s balance sheet. This may impact shareholder returns.
Still, the Asian economy does have tremendous long-term potential. HSBC may encounter some turbulence in the near term, but I am optimistic about its potential over the long run. Its global footprint is a unique competitive advantage, and the company has a strong presence in Hong Kong, which gives it an edge over other Western peers.
Considering these factors, plus the bank’s valuation and growth potential over the next few years, I would be happy to buy the stock for my portfolio today.
Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has recommended HSBC Holdings. 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.
