Hunting for Value in European Stocks

by Charles Sizemore, Sizemore Capital Management

Iā€™ve been bullish on European stocks for the past year based on their vastly cheaper valuations relative to the American market. Iā€™m not quite willing to jump into the Greek market just yet, as there arenā€™t many liquid stocks to choose from, and those that are available arenā€™t quite as cheap as Iā€™d like to see, given the macro risk. But, European stocks as a whole are a fantastic bargain, and the recent selloff presentsĀ a great buying opportunity.

Iā€™ll start with a broad play on developed Europe, theĀ Vanguard FTSE Europe ETFĀ (VGK).

VGK gives you exactly what you want from a Vanguard index fund: instant diversification, tax efficiency and rock-bottom fees. VGK holds a basket of 540 stocks spread across the major economies of the eurozone, as well as non-eurozone countries Norway, Switzerland, and the United Kingdom. As a passive index investment, VGK only turns over about 7% of its portfolio per year, and its expense ratio is a negligible 0.12%.

VGKā€™s largest country weighting, at 31%, goes to the United Kingdom. France, Germany and Switzerland each chip in 14%, and after that the weightings trail off. ā€œProblem childrenā€ Spain and Italy make up only 5.2% and 3.7%, respectively. Looking at industrial sectors, VGK has a pretty conservative bent. About half the portfolio is invested in financials, health care and consumer staples.

If youā€™re looking for instant exposure to the major markets of Europe, this is it. But, if youā€™re looking to play a rebound in the markets hardest hit by the Greek fiasco, you might find that VGK is a little too conservative.

ForĀ more aggressive investors, my next recommendation is theĀ iShares MSCI Spain ETFĀ (EWP). There are relatively few Greek stocks that trade as ADRs, and any investment in Greece shouldĀ be viewed as a coin toss in this environment: Heads, Greece really does stay in the eurozone and Greek stocks rally; tails, we eventually get a Grexit and Greek financial assets drop by another 50% or more. The returns potential is huge, but there is simply too much downside risk for me to get comfortable.

Spain, however, representsĀ a nice risk/reward trade off. While Greeceā€™s economy remained depressed,Ā the Spanish economy is expected to grow 2.8% this year. Regional unrest is a problem, and Catalonia may very well push forward with a referendum on independence. Spain has had regional unrest since the Franco dictatorship, yet life seems to have a way of moving on.

Looking at Spanish stocks, thereā€™s a lot to like. By Research Affiliates estimates, Spanish stocks trade at a cyclically-adjusted price/earnings ratio (ā€œCAPEā€) of just 12,Ā which is less than half the CAPE valuation currently being sported by American stocks.

Spanish stocks also have relatively little exposure to the Spanish economy. Spanish multinationals are active across Europe, and taking advantage of common language and cultural ties, they also have an outsized presence in Latin America.

EWP gives a nice basket of Spanish stocks, including household names likeĀ Banco SantanderĀ (SAN),Ā TelefonicaĀ (TEF) and Zaraā€™s parent companyĀ InditexĀ (IDEXY).

Finally, letā€™s drill down to an individual stock that I expect to perform very well: German luxury automakerĀ Daimler AGĀ (DDAIF).

Traditional auto stocks have been out of favor of late, as investors have flocked to sexier growth stories likeĀ Tesla MotorsĀ (TSLA). Yet, at current prices, Daimler offers a value that is hard to ignore. DDAIF stock trades hands at just 10 times earnings and sports a dividend yield of 3%. Furthermore, after lagging its German rivals for years, Daimler has done a nice job playing catch-up with a redesigned product lineup.

If Chinaā€™s market rout slides into a real ā€œhard landing,ā€ Daimler will feel the pinch, as China makes up a good 13% of revenue. Yet, as recently as last month, Daimler announced that it expects to see sales growth of at least 10% this year in China.

Disclosure: Long DDAIF, EWP, SAN, TEF.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of theĀ Sizemore InsightsĀ blog.Ā 

Photo credit: Chema Concellon

 

Copyright Ā© Sizemore Capital Management

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