Paul Hill's tip of the week: large or small-cap stocks?

published 7 September 2006

Is it best to go for large or small-cap stocks? It's a question investors often debate. Most FTSE 100 companies are covered in minute detail by numerous research analysts, so the share price of large firms tends to reflect their fair values more closely than small caps, solely because of the greater exposure. However, opportunities arise in both sectors, and astute investors will not limit themselves to just one area. Take this blue chip share...

Tip of the week: HSBC (HSBA, 965p), tipped as a BUY by The Times

Take HSBC, for example. It is the world's third-largest bank with a £110bn market capitalisation and is covered by 29 analysts. Normally, a company of this size is correctly priced, but at 950p, HSBC shares offer good long-term value. Let me explain why.

Last week, HSBC released its interim results, beating expectations with an 18% jump in pre-tax profits to £6.7bn. Even more impressive was that revenues and profits increased organically by 13.5% and 16% respectively. Too often it has been claimed by sceptics that HSBC is just too big to expand, but clearly double-digit growth is not a sign of weakness. Specific bright spots came from its emerging markets and private banking divisions.

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The City's principal worries are HSBC's exposure to the UK and US consumers, and its decision to build its own investment bank from scratch. Yet neither area is cause for too much concern. Although underlying bad debts were 13% higher than last year, this was only in line with growth. As a percentage of total loans, the overall credit quality remained stable at 1%. Furthermore, the merchant banking division is powering ahead albeit after a prolonged period of recruitment and saw profits jump 37%.

Frankly, for this level of growth, diversity and quality of earnings, I would rate the shares on at least a 14 times p/e multiple. But in fact, at 965p, HSBC trades on a discount of 12 times earnings and is also paying a chunky 4.4% dividend yield.

So from a valuation perspective, the shares are cheap, especially as management has a conservative track record in managing the firm's cost base and loan book. For instance, chairman Stephen Green said at the interims that, in the first half, the bank had "deliberately reduced its share of the new UK unsecured lending market". As such, in the unlikely event that there was a global recession, HSBC would fare a great deal better than its more aggressive banking peers.

Finally, with the bank's primary focus being on organic growth, rather than making large acquisitions, and the continued development of its emerging markets business, I rate the stock a good long-term buy.

Recommendation: BUY at 965p

Paul Hill's personal portfolio has gone up by 483% over the last five years. To find out more about his own specialist share-tipping service, 'Precision Guided Investments', click on the link below:

Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.

Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.

Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.