LONDON -- Before I decide whether to buy a bank's shares, I always like to look at its return on equity and its core tier 1 capital ratio.
These core financial ratios provide an indication of how successful a bank is at generating profits using shareholders' funds, and of how strong its finances are. As a result, both ratios can have a strong influence on dividend payments and share price growth.
Return on equity
The return a company generates on its shareholders' funds is known as return on equity, or ROE. Return on equity can be calculated by dividing a company's annual earnings by its equity (i.e., the difference between its total assets and its total liabilities) and is expressed as a percentage.
HSBC's share price has risen by 26% in the last year, and the shares have a generous trailing yield of 4.3%. Let's take a look at HSBC's return on equity since 2008:
HSBC's high single-digit average ROE is not bad for a £126-billion company, but ROE figures are most useful for comparing similar businesses, so let's look at some of HSBC's peers.
HSBC vs the competition
HSBC's big strength is its large presence in key emerging markets, particularly in Asia. The bank's only real U.K.-listed peer for emerging markets is Standard Chartered, but HSBC has a much bigger U.K. business, so I've also included Barclays:
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HSBC's ROE is lower than its smaller peer Standard Chartered, but HSBC's core tier 1 capital ratio, which compares the value of a bank's retained profits and equity with its loan book, is stronger than either of its peers.
Indeed, HSBC's cash position is so strong that city analysts are predicting dividend increases of at least 10% in 2013 and 2014, as HSBC seeks to return cash to shareholders.
Is HSBC a buy?
I would never buy a share based on analysts' forecasts alone, but as an existing HSBC shareholder, I'm happy that my bank has the highest core tier 1 capital ratio of all listed U.K. banks, and that its cash balance -- which has grown from $31 billion in 2007 to $148 billion in 2012 -- is so robust.
I also like HSBC's above-average yield and emerging market strength, and believe that HSBC remains an attractive income buy.
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