Place your bets on European stocks

Everyone has their eyes on Mario Draghi this week. But as Matthew Partridge points out, there’s more to Europe than the European Central Bank boss.


Everyone has their eyes on Mario Draghi this week. But as Matthew Partridge points out, there's more to Europe than the European Central Bank boss.

Europe has had a particularly painful recession. While the British recovery is in full swing and America powers ahead, growth in the eurozone is still weak and unemployment high, especially in the hardest-hit countries around half of young Greeks are out of work.

This dismal performance has been reflected in markets. European stocks bounced from their troughs in 2009, but have treaded water since early 2010. While the S&P 500 is up by more than 80% over the past five years, the EuroStoxx index is up by less than 10% (and in dollar terms, it's down by 10%).

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As a result, the burning issue for Europe has been the battle between Berlin and the rest of the eurozone with European Central Bank (ECB) boss Mario Draghi in the middle. Germany, concerned about high debt levels and inflation, has pushed for monetary and fiscal austerity, while demanding that German banks be repaid in full for money they lent out.

However, highly indebted countries, from Greece to Spain, want forgiveness of both public and private debts. Until recently, the German view has broadly prevailed. This week, we'll see if Draghi (and Greek voters come Sunday) change that.

However, this focus on the ECB and 'Grexit' makes it easy to forget that there's more to choosing decent stocks than monetary policy. Certain eurozone stocks should prosper, regardless of what happens with quantitative easing (QE) or interest rates.

The stronger dollar is already boosting profits of firms that export to America. Lower energy costs are swelling bottom lines. Early signs are that European corporate profits will beat expectations this year.

Meanwhile, the poor performance of European shares means valuations look attractive, especially against other countries. According to analyst Mebane Faber, German shares trade at 16 times earnings against 24 for the US. The periphery is even cheaper, with the Greek market on a cyclically adjusted price/earnings ratio (Cape) of less than three.

In short, a few European sectors look 'Brussels proof' they are such good value and decent quality that you should buy them irrespective of what happens to the eurozone.

Below I've focused on carmakers and renewable energy firms. And on the more domestically focused side, the small companies sector is starting to rally after bearing the brunt of the post-financial-crisis slump in lending.

The car comeback

The European car industry has been hit hard by recession. With incomes falling and unemployment rising, European consumers haven't had the money to replace existing cars. High fuel prices have been an added incentive to use public transport.

This is on top of the fact that car ownership rates, especially among young urban dwellers, have been slipping since the 1990s. In all, annual car sales in Europe have slid continuously from 2008 to 2013 domestic sales in Spain, for example, have halved.

But things seem to have turned a corner. Sales volumes rose by 5% last year. That's partly due to people feeling confident enough to replace their old cars (and simple necessity probably plays a role too).

Also, because of the importance of the car industry to jobs, governments have tried to speed this process using incentive schemes offering cash or discounts for those who replace ageing "clunkers" with newer vehicles.

One of the most aggressive efforts has come from Spain. The government offers up to €2,000 towards the cost of a new car for each old vehicle destroyed, with the cost split between the state and carmakers. Earlier versions of the scheme failed to halt the decline, but this version seems to be working sales were up by 18.9% last year.

European companies have also adapted to conditions by producing budget versions of popular models. Industry experts expect European sales to rise by a further 3% this year.

A European car industry recovery is good for Volkswagen (Germany: VOW), which has a 25% market share in the European Union two-thirds of its sales revenue comes from Europe.

The Skoda and Seat brands cater to the budget market, while its Audi and Porsche brands benefit from demand for high-end vehicles (Audi recently made waves when a prototype completed a 560-mile journey with minimal human intervention). The stock is attractively priced on eight times earnings.

Another company worth considering, particularly with driverless cars in mind, is Daimler (Germany: DAI), which owns Mercedes. It is a leader in the race to bring the first entirely automated car to market.

It unveiled a working model (the F-015) at this year's Consumer Electronics Show inLas Vegas. It also has plenty of cash and plans to launch several new models later this year. It currently trades at a price/earning (p/e) ratio of around ten, making it solid value.

Tenacious turbines

The renewable energy sector should also continue to do well. The collapse in the oil price (and coincident drop in gas prices) may make solar and wind power less attractive on a cost basis, but support for investment in renewables to cut carbon emissions remains strong in both Brussels and individual European countries.

You can even make the case that falling fossil fuel prices make it easier for power companies to increase the proportion of energy generated from renewables, while cutting overall bills.

With a few exceptions, Europe is close to meeting its target of every member state producing 20% of energy from renewables by 2020 already 15% of energy EU-wide is green, and it is aiming for 27% by 2030. Other countries have gone further Germany gets a quarter of its total energy from renewables and hopes to raise this to 80% by 2050.

This investment will do more than just help European firms directly. It should allow them to gain a head start on their global rivals, putting them in pole position to win contracts around the world.

For example, according to the European Wind Energy Association, EU wind turbine firms already account for a third of the US market, and a 40% share of the global market. Tellingly, non-EU firms have had little success in winning contracts within the EU they account for just 11% of the European market.

That's promising for Vestas Wind Systems (Germany: VWS). This Danish company makes, installs, and services wind turbines around the world.

It is particularly dominant in the fast-growing offshore area it has installed just under a third of the world's total offshore wind capacity. Recent deals include contracts for wind farms in Poland and Italy, as well as a six-farm project, totalling one gigawatt of capacity, in Norway (loosely speaking, that's enough to power around 750,000 homes).

Vestas has also agreed a deal with Mitsubishi that should help to maintain its technological edge and enter Asian markets. It's on a 2015 p/e of 16.

Spanish engineer Abengoa (Nasdaq: ABGB) has also used the growth of renewables within Europe to establish itself on the global stage. It operates everything from solar energy projects to biomass plants, using biotechnology to develop processes that will make it easier to extract energy from plant material. Its current p/e of 20 falls to just 11for 2016. It also trades at just belowbook value.

The lending drought eases

The recession has seen a dramatic collapse in bank lending in Europe. Large multinationals have been able to insulate themselves, but the very smallest firms saw bank credit all but dry up in Spain, bank lending to firms with turnover of less than €1m fell by 60%. While this is an extreme, significant drops were also seen in France and Germany, while eurozone-wide bank lending to very small firms fell by 40%.

However, things are looking up. European governments are putting pressure on banks to lend more to smaller firms, and granting tax breaks to encourage alternative investment.

Economic reforms would also make it easier for smaller companies to take market share from larger rivals. As a result, profits are expected to grow strongly this year. Indeed, there is even hope that a new wave of mergers and acquisitions may take off in Europe.

One investment trust worth considering is the Montanaro European Smaller Companies Trust (LSE: MTE). As the name suggests, it invests in a range of European small caps, with an emphasis on fast-growing stocks. Its current focus is on industrial companies and those selling consumer discretionary goods.

Financials and information technology also account for a large chunk of the portfolio. Experienced managerCharles Montanaro is in charge (disclosure: MoneyWeek editor-in-chief Merryn Somerset Webb isalso a non-executive director). The total expense ratiois 1.46% and it trades on a discount to net asset value of 12%.

Alternatively, you could consider a low-cost exchange-traded fund (ETF). A popular ETF for European small caps is the SPDR MSCI Europe Small Cap UCITS (France: SMC). This tracks the main European small-cap index. Its main attraction is the tiny total expense ratio of 0.3%. It trades on a p/e of 16 for 2015, and yields 2.7%.

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri