What is the expected rate of return of Hang Seng Index? (as of 3rd October 2022)

The Hang Seng Index (HSI) closed at 17079.51 points on October 3rd, down 34.9% from its 52-week high of 26,234.94 points. The index has clearly undergone a significant correction and is now in bear market territory. This short post attempts to estimate the expected rate of return of the Hang Seng Index with help from Bloomberg and Aswath Damodaran's lecture notes.

At this level, the Hang Seng Index is trading at very reasonable valuations by most measures.

According to Bloomberg, it currently has a Price to Earnings ratio (PE) of 6.45.

The price-to-book and price-to-sales ratios are 0.6958 and 0.8152, respectively.

Earnings per share can be calculated using the PE ratio as 17079.51/6.45 = 2648 HK$.

The Book Value per share can be calculated using the PBV ratio as 17079.51/0.6958 = 24,546.6 HK$.

The Sales per share can be estimated using the PS ratio to be 20,951.3 HK$.

The estimated Return on Equity (ROE) is 2648/24546.6 = 10.79%.

Assuming that the HSI is a stable growth company, the relationship between its Price to Book Value ratio and Return on Equity is as follows:

The above equation (source: Damodaran) can be used to estimate the expected rate of return based on the current PBV ratio of the Hang Seng Index.

Assuming a conservative stable growth rate of 3% for the HSI in perpetuity,

PBV = 0.6958 = (0.1079 – 0.03)/(r-0.03) (r-0.03)

When the above problem is solved, the r value is 0.1420, or 14.20% per year.

By any standard, an expected rate of return or compounded annual growth rate (CAGR) of 14.2% is respectable.

While there is no guarantee that the Hang Seng Index will not fall further at this level, it may be time to dip a toe in the water.