Europe offers good value

Private investors should not be deterred from investing in Europe by Greece’s sovereign debt crisis, according to market analysts, but should instead look for opportunities created by increased merger and acquisition (M&A) activity. Many now believe the prospects for continental equities are improving, despite the general sell-off.

“This represents a buying opportunity in the broader European market,” says James Buckley, head of Pan-European large-cap stocks with Baring Asset Management. “Greece has caught a lot of attention, but it’s quite minor in many ways. Greece is a small stock market and it’s a localised problem.”

In fact, central and eastern European markets have been the strongest performers in the world in the past six months, as they have been buoyed by the determination of governments in the region to straighten out their public finances.

Investors’ enthusiasm for attractively valued companies listed in Milan, Paris and Berlin is also growing following forecasts of more M&A deals involving small-to-medium-sized European companies.

In sterling terms, since 1999, Europe is the second-best performing market after Asia-Pacific, according to research from the investment advisory group Rowan & Co.

The French CAC 40 stock-market index and the DAX in Germany both look cheap, as they trade at close to 12 times this year’s earnings – a lower ratio than at any time in the past three and half years.

An added attraction is the dividend yield on these stocks. The average yield provided by companies listed on the Euro Stoxx 50 is 4.4 per cent, which compares favourably to the 2.06 per cent average yield on the S&P 500.

“Europe is more attractively valued than Brazil, India, China, the US and the UK on a price-to-book basis,” adds Tim Cockerill, head of research with Rowan. “The major con is currency – and at present, the euro looks expensive.”

Fears of instability in the bond markets – which are now suffering the effects of the ending of the Bank of England’s gilt buyback programme – are also encouraging renewed interest in European markets from income investors.

“If you buy European equities, you get an annual dividend, which is the same as what you would get on bonds, but you also have the advantage of gaining capital appreciation,” claims Gary Clarke, head of European equities with Schroders. “The risk-reward equation is better for equities than it is for bonds.”

Schroders’ Clarke expects European companies’ margins will only improve in the next three years. Strong fourth-quarter results from Nokia, the Finnish mobile group, and the German industrial group Siemens are positive omens, he says.

Cost-cutting efforts also help. “Many of the cyclical companies have cut up to 30 per cent of their workforce and the average industrial company has got rid of at least 10 per cent of their fixed costs,” says Clarke.

Buckley of Baring Asset Management suggests focusing on telecoms stocks such as Telecom Italia, which is rumoured to be the target of a bid from Spanish rival Telefónica and offers a 7 per cent dividend yield.

Heineken, Tesco, and Nestle are three other defensive plays, according to Schroders’ Clarke. Cyclical companies – whose fortunes are linked to the economic cycle – present opportunities as well, particularly for the bulls who believe the world’s economy is improving, fund managers say.

Alister Hibbert, manager of BlackRock’s European Dynamic fund, says buying into Europe also offers the chance to gain emerging markets exposure. About 23 per cent of quoted European companies’ revenues come from emerging markets, he estimates. He favours luxury good groups such as Swatch and LVMH, which continue to benefit from higher sales in Asia.