Why I think the HSBC share price could be set to bounce back to 700p

Over the past six months, shares in HSBC(LSE: HSBA), one of the world’s largest banks, have slipped 11% excluding dividends.

This performance is disappointing mainly because it now means that the bank is underperforming the broader FTSE 100. Over the same period, the UK’s leading share index has declined just 5% excluding distributions to investors.

Year-to-date, the performance gap is even wider. Since the beginning of 2018, shares in HSBC have underperformed the FTSE 100 by 8.8%.

Still, one of HSBC’s most attractive qualities is its dividend income and today, the stock supports a dividend yield of 6.4%, making it one of the most attractive income stocks on the market. But by adding distributions to investors into the figures, the underperformance is only slightly better. Year-to-date, including dividends, HSBC has underperformed the FTSE 100 by 7.8%.

What’s going on?

It seems there are several different reasons why HSBC has lagged the broader market this year.

First off, we have Trump’s trade war with China, HSBC’s largest market. There are already some signs that this war is having an impact on Chinese economic growth although policymakers have been quick to act to try and cushion the decline.

Second, it appears to me that investors have been selling the stock due to its elevated valuation compared to the rest of the UK banking sector. At the beginning of 2018, the shares were changing hands for around 14.3 times forward earnings, a premium more than 50% above the rest of the UK finance sector. Today, HSBC’s valuation has moderated slightly. The shares are currently changing hands for 10.8 times forward earnings — still a premium to UK listed peers, which have a median P/E of 8.5.

Although this comparison makes HSBC look expensive compared to the rest of the industry, I believe that the banking group does deserve a premium multiple because of its international exposure. How much of a premium does it deserve though? That’s a difficult question to answer. The company’s peers of comparable size in the US are trading at a median forward P/E of around 12. Meanwhile, over in China, shares in the country’s largest banks are changing hands for between six and eight times forward earnings.

Placing a value on the shares

I reckon a valuation of between 11 and 12 times forward earnings might be more suitable for HSBC. While the bank does have a large part of its business located within China, other businesses in the UK and US also make up a significant portion of earnings. What’s more, the group’s globally integrated business is worth a premium as many of HSBC’s peers have failed to establish a strong foothold in Asia in the same way.

City analysts are forecasting earnings per share of $0.76 or 58p for 2019, and on this basis, a P/E of 12 would justify a share price of around 700p. Including the group’s 6.4% dividend yield, this indicates an upside of 14.1% is on offer for investors in the medium term.

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Rupert Hargreaves owns no share 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.