Buttonwood in The Economist (June 2, 2012) makes a case for value investing opportunities in European stocks. Reasons for considering an investment in European equities include the following:
1. All the bad news is likely reflected in the price, and hence, contrarians should turn bullish.
2. Europe has many world-class companies that have diversified revenue streams and that are not dependent on the fortunes of peripheral members of the euro zone.
3. In some European countries, the dividend yield is much higher than the yield on cash or on ten- year government bonds. The average dividend yield on European shares is 4.1%; the American market offers a yield of only 2.2%.
4. European equities are trading on a cyclically adjusted price-earnings ratio—a measure that averages profits over seven years—of 11, towards the bottom of its range over the past 30 years.
We constructed a screen with the above four Buttonwood arguments in mind:
1. We considered stocks that have lagged their peers in the last 12 months and in the last 30 days on share price performance i.e. those that have possibly been beaten down by the bad news emerging from the continent.
2. Companies with potential globally diversified revenue streams. We used market size as a proxy for companies that can afford larger operations; our cut-off is $500 million or more in market capitalization.
3. Stocks with a dividend yields of 4% or higher.
4. Stocks trading at price-earnings ratio of 11 or lower.
The screen resulted in about 100 equities domiciled in the EU. We refined the screen further to consider more specific Value Investing principles.
1. Stocks trading at valuations lower than their peers and thus ‘cheap’.
2. We considered safety in the dividend by looking for companies with ‘High Quality Dividends’ i.e. the dividend payment is comfortably covered by operating cash flows.
3. Companies and their managements that seem to have created borrowing capacity for their operations i.e. ‘Quick and Able’ to borrow should the need arise to be opportunistic when economic tailwinds do appear.
The result: Three companies – a UK retailer (Tesco), a Croatian telecom operator (Hrvatski Telekom) and a German Solar technology firm (SMA Solar). For additional details, please see the table below. An added bonus: All of them trade well off (about 25% or more) their 52-week highs. And given the beaten up stock prices with the benefit of possibly protected dividends, might these be value?