With political uncertainty spreading across Europe, equity investors are feeling anxious. By focusing on companies that aren’t really exposed to regional instability, we think investors can discover resilient sources of return potential.
For investors seeking returns in Europe, equities present a conundrum. Compared with bond yields, which remain stuck near historic lows, stocks look very attractive. Yet equity markets also look vulnerable to a range of issues from a possible renewal of the Greek debt crisis to Brexit and the populist challenge in elections in several major countries.
Political risk cannot be ignored. But not every stock is affected in the same way. Some European companies, such as banks in countries with weaker sovereign debt, are highly sensitive to domestic politics. Many others are global players that benefit from positive trends around the world, but have stocks that trade at discounted prices in part because of the unsettled regional landscape.
Déjà Vu: 2012 All Over Again?
It feels a little like 2012. At the time, Europe was engulfed in a sovereign-debt crisis that threatened to undermine the regional currency. Stocks looked scary. Yet there were plenty of attractively valued shares on offer at the time that simply weren’t affected by the surrounding events.
Take Ubisoft as an example. In 2012, shares of the French software games company were depressed amid concerns about delays for the next release of its popular Assassin’s Creed game franchise. Investors who studied the company at the time could determine that the delay would be temporary and global sales would be unaffected by concerns about the euro and French banks. Shares of Ubisoft rose more than sevenfold from 2012 through the end of 2016.
German robot manufacturer Kuka also emerged unscathed from the European crisis. At the time, investors were concerned that Kuka’s revenues from European carmakers would be hit by falling auto sales. In fact, the number of robots used to manufacture vehicles has steadily increased, driven by demand from China where companies are keen to combat rising labor costs and improve quality. Kuka’s stock has also surged since 2012.
Business Dynamics vs. Political Noise
What do these examples have to do with today’s markets? In both cases, investors who focused on companies and not countries could isolate individual business dynamics from external political and economic trends to gain conviction in an investment thesis. And in both cases, maintaining a long-term perspective—even when markets were fixated on short-term noise—was the decisive element.
Today, European stock markets offer abundant opportunities. European equities are attractively valued, in our view, at a price/forward earnings ratio of about 15x—an 8% discount to global developed stocks and a 17% discount to US stocks (Display, left). High-beta stocks, which are generally considered riskier, trade at very deep price/book discounts versus low-beta stocks. In other words, many investors are still overpaying for perceived safety, creating plentiful mispricing for stock pickers to exploit.