The outlook for the UK and European economies may be dire but that doesn’t mean that the region’s companies don’t offer compelling investment opportunities. That was one of the key messages to emerge from an equity valuation session at the Morningstar Investment Conference in Chicago this week.
“I don’t know how [the eurozone] is going to pan out, but at current valuations you’re going to have tremendous returns,” commented Doug Ramsey of Leuthold Funds in reference to investing in European equities. When you invest in European equities you’re not tethering your portfolio to the region’s weak economic outlook, instead you’re capturing regional companies’ extensive exposure to emerging markets. European companies also offer access to US growth but at more attractive multiples than US equities at present, Ramsey and fellow US asset manager Steve Romick of First Pacific Advisors explained.
While fellow panellist Mason Hawkins of Southeastern Asset Management extolled the virtues of investing in natural gas companies in the US, Ramsey and Romick seemed decidedly more excited by Europe. At an average price/earnings multiple of less than 10x*, MSCI Europe companies are not only much more attractively priced than US equities, which currently trade closer to an average P/E of 20x, but are virtually discounting zero growth, said Ramsey. “Europe is one area that has a 4% dividend yield that no-one wants a piece of,” Ramsey exclaimed.
Ramsey’s analysis of historical stock market data suggests that when an asset or region is experiencing net outflows, this can be a useful contrarian bullish indicator.
Turning to specific stock picks, Romick pinpoints two companies that he’s a fan of. The first is UK advertising giant WPP (WPP), which generates approximately 12% of revenues from the UK, 20% from emerging economies and 25% from Europe. That Europe exposure means that the company will feel a little pain from the Continent’s debt crisis, Romick conceded, but this is a temporary effect that doesn’t impact its long-term potential. WPP is currently rated 3 Stars by Morningstar, implying it is broadly fairly valued by the market.
Second up on Romick’s list non-US stock picks is Renault (RNO). This stock is a favourite of the manager not because he’s upbeat on the auto sector, nor because the company’s balance sheet “is the best it’s been in a couple of decades,” but because of its stakes in other companies of interest. Nissan, Volvo and Daimler—it’s Renault’s stakes in these companies that makes the firm valuable in Romick’s eyes. Renault currently carries a 5-Star rating, implying the stock is undervalued relative to Morningstar's fair value.
In his summary comments, Ramsey responded to a question from the audience by stating that “[US] stocks will trounce fixed income over the next 8-10 years, no doubt about it, but that doesn’t mean they’re cheap on an absolute basis. Where they are truly cheap is outside the US.”
*MSCI Europe P/E on 5-year normalised EPS basis (60-month moving average of 12-month trailing EPS), May 2012
