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 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:
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 onto them, collecting dividends and waiting for sentiment to turn upwards once again.
Retirement Investing Today says
I popped HSBA into my HYP back in March 2014 at £6.2119. Now £5.992 but still happy to be holding on a 4.8% trailing dividend yield (5.2% forecast). With HSBA (plus my other HYP shares) I’m trying to buy an income that will rise at or above inflation over the long term
John Kingham says
Hi RIT, didn’t realise you were a HYP man! I thought you were passive MPT through and through?
HYP is certainly a pretty decent way to build an inflation-busting income portfolio, although I’m not a big fan of buy-and-forget… I prefer to be a bit more active myself, although obviously that system is tweakable to taste.
Keep up the good work on your site.
Retirement Investing Today says
Your right majority of my portfolio is passive mechanical MPT with a dab of market valuation tweaking. I’m happy with the results this is bringing.
Strategy though requires me to work more towards stable income as I near financial independence to give me the option of ‘stable’ early retirement. I believe HYP gives me that and so it will form a part of my overall portfolio.
Started slowly building the HYP in November 2011. Now own SBRY, AZN, SSE, VOD, RMG (not really HYP but couldn’t turn down free money), HSBA, PSON and RDSB so some way still to go. The remainder will be built in the next 3 years.
Banks’ profitability is a function of yield curve . When the yield curve is very steep banks should make money , when the yield becomes flatter as in 2006 and probably in 2015-2016, banks can’t make money.
I have been lucky to learn this from Peter Lynch book, so I sold all my banks shares in 2006. I have to admit there was a bit of luck as well (luck always helps in investments).
Obviously in 2006 bankers tried to keep making money against a flat yield and asked their investment bankers for the last push in dicing mortgages and financial engineering. The retail arm did the last push in selling more PPI and derivative based products, all with a view to make profits for the bottom line.
There are very few investors who understand how banks make money or how to value a bank properly. I can understand the first, but not the second, so I don ‘t invest in banks unless there is a clear safety margin. There isn’t one now.
Banks make money when they borrow cheap on short term and lend expensive for long term and profit from the difference, so understanding the yield curve is very important.
Obviously the regulatory overlay adds more uncertainty to investing in banks: discussions about breaking them up in more entities to have more competition etc. Competition may be good for the real economy but not good for banks share prices.
In conclusion I prefer to invest in the real economy. I took a new position in the energy sector at the start of May through a fund this time – Artemis Global Energy – about 7% of my portfolio (which is only 40% of what it used to be 14 months ago) – as I don’t like what I see in Ukraine. If the gas will not flow this winter through Ukraine, there will be big problems and energy companies will benefit and not to say this sector is cheap anyway, so it should re-rate. I have also increased my exposure to Japan equity (as an insurance policy) through a fund and by buying more Japan Tobacco, my favourite Japanese stock.
I bought some index-linked gilts as well, not much only 8% of my portfolio – I smell a bit of inflation, but I may be wrong here.
I can go in holiday now!
John Kingham says
Hi Eugen, I agree with you that banks are very hard to understand, especially the vast mega-banks like HSBC. But personally I don’t mind if I don’t totally understand a business because I don’t think I really understand most of the businesses I invest in.
Even something simple like Greggs the Baker which makes pies and cakes and sells them on the high street; it sounds pretty simple but I don’t really understand the details of how they run the business. That’s why, as a shareholder, I employ hundreds of people in the business who do know (more or less) what they’re doing.
However, I do appreciate that banks are super-complex and so I wouldn’t own more than a couple of them to minimise my exposure. I generally hold 30 stocks so I doubt that banks would ever make up more than 10% of my portfolio. I tend to agree with Buffett that diversification is protection against ignorance.
Adam Okhai says
Suggest you have a look at Canadian banks. Although they are up significantly , ratios indicate value. Well run. Excellent regulator.
PS: I am resident in Ontario. I stumbled into your site when looking for a UK online broker. Your value invest investing letter is insightful. Wish you very best, Adam Okhai
John Kingham says
Hi Adam, thanks for your suggestion on Canadian banks. However, for now I’m 100% focused on UK-listed companies so perhaps another time. I know I have other Canadian readers too so I’m sure they’ll appreciate your suggestion.
Your suggestion is not bad. I looked once at RBC and it true it has a very good balance sheet and it can take advantage buying discounting assets from our banks.
However I am wary of banks based in countries with high exposure to mining. I learned this investing in Australian banks a couple of years ago. The start was good and I was easily 40% up. However the currency exchange rate started to move against me and my initially profit started easily to vanish, forcing me to sell. Exchange rates are important, and C$ as the A$ are very volatile currencies.
I have to admit that given the problems with Russian gas deliveries, anything related with energy could re-rate and why not Canadian banks as well.