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He FTSE 100 Index's HSBC Bank (LSE: HSBA) is not only the largest of the UK's “big four” banks. It is also the largest bank in Europe and one of the top 10 globally, with total assets of more than $3 trillion.
I think this gives it more scope to exploit the different banking opportunities that exist around the world and mitigate the risks that come with them.
The main problem facing the UK is the decline in the net interest margin (NIM) as interest rates fall. The NIM is the difference between what a bank charges on loans and what it earns on deposits.
Overall, however, analysts' consensus estimates are for revenue to grow 3% annually through the end of 2026, with ROE projected to be 12.3% by that date.
A high-performance gem?
In my experience, increases in revenue tend to boost a company's dividends (and stock price) over time.
Last year, HSBC paid a total dividend of 61 pence (46p) per share. At the current share price of £6.65, this gives a yield of 6.9%. In contrast, the average yield for the FTSE 100 index right now is 3.7%.
So if you invested the average UK savings amount (£11,000) in HSBC, you would get £759 in dividends in the first year.
Over 10 years, this figure would rise to £7,590, assuming the average return remained the same. And over 30 years, on the same basis, the figure would be £22,770.
This is much better than what you could get with any standard UK savings account. It is also much better than the current 4% I can get with the UK 10-year bond (“the risk-free rate”).
Turbocharging those returns!
However, if I were to buy more HSBC shares with the dividends they pay me, the increase in dividend returns could be huge!
This is called “dividend compounding” and is the same idea as letting interest accumulate in a bank account.
After ten years of doing this with the same return, you would have earned £10,888 more, instead of £7,590. And after thirty years on the same basis, the investment would have earned £75,658 more, instead of £22,770.
Together with the initial investment of £11,000, this would pay out £5,979 each year in dividend income at that stage!
The icing on the cake?
After generating all this income, I would not want it to disappear due to prolonged losses in the share price.
The way I try to offset this risk is by selecting stocks that pay high dividends but also appear undervalued.
HSBC looks very cheap to me on several key equity valuation metrics. For example, on the price-to-earnings measure, it trades at just 7.1, compared to an average of 8 among its peers.
That's cheap, and it looks even cheaper when compared to the European peer group average of 7.5.
So how much is a bargain? A thorough discounted cash flow analysis shows that HSBC is 58% undervalued at its current price of £6.65.
A fair value would therefore be £15.83, although of course it could be lower or higher.
Will I buy more?
Given this extreme undervaluation, its high yield and solid growth prospects, I will be buying more HSBC shares very soon.