by George MizziThe case for European equities seems to be a simple one. By most measures, the US market is more expensive. It generally pays to buy cheaper stocks. Therefore, buy Europe!
Such line of reasoning does not go down well with some analysts. US stocks have outperformed their European counterparts year after year for the past decade, at least. So if the past is your guide, why put your money on a horse that never wins?
A common measure of the value of a share is the forward price-to-earnings ratio (P/E). This compares the current price of the share to the expected earnings per share. Therefore, the higher the numerical value of the forward P/E, the more expensive the share.
European equities currently have an average forward P/E of about 13.75, compared to 17.25 for US equities. In other words, European equities are more than 20 percent cheaper.
So why are global investors reluctant to put more money in European equities?
One theory is that, within the US market there is a profusion of super-profitable and nimble technology titans such as Amazon, Google and Facebook. Europe has no such technology behemoths. Its equity market is more tilted towards traditional and mature industries where bottom-line growth rates are stable and predictable, but certainly not exiting.
However, sector differences alone do not explain away the valuation gap; US equities also have better fundamentals.
A key measure of financial performance is the Return on Equity (ROE). This is calculated by dividing net income of the company by the shareholders' equity. The average ROE of US equities has increased from three percent in the aftermath of the financial crisis to just over eight percent today. In contrast, the ROE on this side of the Atlantic rose from 1.5 percent in 2009 to just under four percent today. With consistently better ROE, US equity assets no doubt look more attractive.
Finally there are economic growth issues. Since the 2007-2009 financial crisis, the US economy has performed better than the European economy. The resulting discrepancy had a profound impact on the respective equity price growth rates.
One may reasonably argue that such “glass half empty” approach overlooks the fact that Europe has one of the highest levels of dividend yield supported by strong free cash flow generation. One also has to keep in mind that US equities would lose their shine if the US economy falters.
So should it be Europe or US?
George Mizzi is a business graduate, an Associate of the Chartered Institute of Bankers and CeFA qualified. He currently works as a fund and technical analyst at Bank of Valletta Wealth Management. For more information about investments contact [email protected]
This article is not and should not be construed as an offer or recommendation to sell or solicitation of an offer to purchase or subscribe for any investment. The writer and the Company have obtained the information contained in this document from sources they believe to be reliable but they have not independently verified the information contained herein and therefore its accuracy cannot be guaranteed. The writer and the Company make no guarantees, representations or warranties and accept no responsibility or liability as to the accuracy or completeness of the information contained in this document. They have no obligation to update, modify or amend this article or to otherwise notify a reader thereof in the event that any matter stated therein, or any opinion, projection, forecast or estimate set for the herein changes or subsequently becomes inaccurate. Furthermore, past performance is not necessarily indicative of future results. The value of investments may go down as well as up and may be affected by changes in currency exchange rates.
Terms and conditions are available from www.bov.com. Issued by Bank of Valletta p.l.c., 58, Triq San Zakkarija, Il-Belt Valletta VLT 1130. Bank of Valletta p.l.c. is a public limited company regulated by the Malta Financial Services Authority and is licensed to carry out the business of banking and investment services in terms of the Banking Act (Cap.371 of the Laws of Malta) and the Investment Services Act (Cap.370 of the Laws of Malta).