Why Europe’s Earnings Rebound Could Offer a Fillip for Active Value Investors

Why Europe’s Earnings Rebound Could Offer a Fillip for Active Value Investors




by Dylan Ball, Executive VP, Franklin Templeton Global Equity Group

European value investing is a strategy that many investors have tended to overlook in recent years. But in fact, since 1999, the European value style has outperformed the growth style and has shown particular resilience when global value and non-US equities have generally struggled.1 Dylan Ball, executive vice president, Templeton Global Equity Group, explains why he thinks it’s time for European value investing to shine.

European equities have seen a general resurgence in investor interest in recent quarters, mostly from passive inflows. However, we believe the general uptick in investor interest has been for good reasons given the positive conditions in Europe right now.

We see signs that European companies are beginning to return to corporate earnings growth, and we believe we will see fundamentals reassert themselves at the heart of investment decisions. Against that background, we see strong value in active European equity strategies right now.

Two Strands: Valuations and Earnings

Many stock market indexes across the world have reached all-time highs recently. However, price-to-book values in Europe remain below their long-term averages, in some cases by up to one standard deviation.2

So we reckon there’s a good case for value opportunities in Europe. Active managers can look through the index to valuations on a company-by-company basis.

A Potential Two-Fold Opportunity

We see a potential two-fold opportunity. Europe’s price-to-earnings (P/E) levels are low on an historical basis.3 And there are signs of recovering corporate earnings across the region. We’re already seeing evidence via stock prices of investors trying to anticipate the early stages of an earnings rebound.

As you can see in the chart below, the current normalised P/E ratio—which is used to strip out short-term seasonal effects—is 19.2 for Europe. In the United States, the multiple is nearly 29 times.

That’s a startling difference, in our view. When we look at normalised P/E ratios on a historical basis, the long-term average P/E ratio in Europe is 21.5. So, we believe there should be plenty of upside potential for European equities.

At the same time, it’s clear that European corporate earnings are still trying to recover fully from the 2007–2009 Global Financial Crisis as has already occurred in other regions.

Reasons for Optimism

There are other reasons for optimism, in our view. In particular, there are signs of a macroeconomic recovery underway.

We believe the devaluation of the euro seems to be coming to a close, and we consider that generally to be a good sign for European equities. It shows that a recovery of some sorts is underway. And the opportunities to potentially profit from the devaluation of the currency against the dollar are not what they were two to three years ago.

Looking at the credit cycle, loan growth has been positive since 2015. In fact, we’re currently seeing positive loan growth of around 2-3%4, and not just in corporate lending portfolios but also in household portfolios. (See chart below).

In addition, by the end of August 2017, eurozone unemployment was at an eight-year low,5 while the eurozone manufacturing purchasing managers’ index (PMI)6 was at a six-year high.7 In the second quarter of 2017, European gross domestic product (GDP) growth was above US levels for the first time since 2007.8

What Does This Mean For Investors?

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