The FTSE 100’s HSBC (LSE: HSBA) is not just the biggest of the UK’s ‘Big Four’ banks. It is also the largest bank in Europe and a top 10 bank globally, with total assets of $3trn+.
This allows it more scope to exploit the differing banking opportunities around the world, and to mitigate the accompanying risks, I think.
The main one it faces in the UK is declining net interest margin (NIM) as interest rates fall. The NIM is the difference between what a bank charges for loans and what it makes from deposits.
Overall though, consensus analysts’ estimates are that its revenue will grow by 3% a year to end-2026. And return on equity is forecast to be 12.3% by that time.
A high-yield gem?
Rises in revenue tend to power a firm’s dividends (and share price) higher over time, in my experience.
Last year, HSBC paid a total dividend of 61 cents (46p) a share. On the current stock price of £6.65, this generates a yield of 6.9%. By contrast, the average FTSE 100 yield at the moment is 3.7%.
So, if I invested the average UK savings amount (£11,000) in HSBC, I would make £759 in dividends in the first year.
Over 10 years, this would rise to £7,590, provided the yield averaged the same. And over 30 years on the same basis, the figure would be £22,770.
This is a lot better than could be had from any standard UK savings account. It is also much better than the current 4% I can make from the 10-year UK bond (‘the risk-free rate’).
Turbocharging those returns!
However, if I bought more HSBC shares with the dividends paid to me, the boost to the dividend returns could be huge!
This is called ‘dividend compounding’ and is the same idea as leaving interest to accumulate in a bank account.
After 10 years of doing this on the same yield, I would have made an extra £10,888, not £7,590. And after 30 years on the same basis, the investment would have generated an additional £75,658 rather than £22,770.
Together with the £11,000 initial investment, this would pay £5,979 every year in dividend income by that stage!
The icing on the cake?
Having generated all this income, I would not want it wiped out by extended losses in the share price.
The way I try to offset this risk is by selecting high-dividend-paying shares that also look undervalued.
HSBC looks very cheap to me on several key measures of stock valuation. For example, on the price-to-earnings measurement, it trades at just at 7.1, against a peer group average of 8.
That is cheap, and it looks even more so against its European peer group average of 7.5.
So, how much if a bargain is it? A comprehensive discounted cash flow analysis shows HSBC to be 58% undervalued at its current share price of £6.65.
Therefore, a fair value would be £15.83, although it may go lower or higher than that, of course.
Will I buy more?
Given this extreme undervaluation, its high yield, and its solid growth prospects, I will be buying more HSBC shares very soon.
This post was originally published on Motley Fool
