For many investors, it’s a surprise that Germany is home to the world’s best performing equity market.
While Japan and the United States have generated the headlines, the German DAX Index has climbed 22.19 percent year to date while the Standard and Poor’s 500 has climbed .05 percent in Canadian dollar terms and the Japanese Nikkei Index has allowed for only a 7.15 percent return.
Beyond the scope of Germany, more optimistic data has been released recently in the region’s largest economy, France.
I believe Europe’s equity market prices are based on extremely low earnings, but probably those growth expectations will be exceeded – a trend that would benefit investors.
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On the surface, the European economic landscape is nothing to write home about.
German gross domestic product or GDP growth was stronger than expected during the third quarter, but with only a 0.2 percent increase.
More positively, consumer spending in France is increasing rapidly, rising 4.5 percent during August and September.
However, European equities look far more interesting at the earnings growth level.
Aggregate earnings, according to Merrill Lynch, are expected to increase from two percent in 2003 to 11 percent in 2004.
If accurate, this sharp increase would translate into considerable capital appreciation for investors.
As well, upward earnings revisions, as a percentage of all earnings projections, are running well ahead of historical levels.
In comparison to North America, valuation levels in Europe are compelling. Continental European equities are trading at 12.6 times 2004 estimated earnings. In comparison, North American equities trade at multiples of 15.5.
Dividend yield is also much easier to find in Europe, as the overall market generates 2.7 percent yield in relation to the S&P 500’s 2.1 percent.
Another way to look at valuation is to compare PEG ratios (price/earnings multiple divided by projected growth rate) to sum up the relative value of the U.S. and European markets.
A PEG ratio is used to determine a stock’s value while taking into account earnings growth. When earnings growth is inexpensive, a market can be considered to be more attractive.
The PEG ratio of Germany and France is 0.6 and 1.1, respectively, considerably less expensive than the U.S. market’s 1.7 ratio.
According to Credit Suisse First Boston strategist Andrew Garthwaite, European equities are trading at a steep discount to U.S. equities in terms of profitability.
By his estimation, European companies are six percent less profitable, but trade at a 35 percent discount to U.S. counterparts.
