Are Eurozone Equities good value (Part 2)

Following on from my previous post (part1) looking inside the main indices to ascertain what is driving the valuation of European markets, I will turn my attention in the post to the four major equity markets in the Eurozone.

The price/book multiple for the European equity market has been de-rating for almost 11 years now. I am hoping that it is not simply the very low valuation attaching to financial equities that is driving this de-rating.


G&D PE: 17x

P/B: 1.27x

The DAX index had a pretty poor 2011, closing down 12%. In general, many of the equities quoted on the DAX are pretty expensive in terms of long term valuation metrics. There are only six stocks with PE10 in below 12. Three are financials (Allianz, Deutsche Bank & Munich Re) Heidelberg Cement, E.On & RWE make up the remainder.

I may have a deeper look at EOn at some stage, having already undertaken some initial research on the stock. RWE, I simply do not like the look of the balance sheet. It is unsurprising to find that Heidelberg Cement among the cheapest stocks in the index.

There are many stocks in the index that are trading on very high Graham & Dodd PE’s and P/B ratios for what are essentially cyclical industrial stocks.  To my mind, stocks such as Volkswagen Group (93% gearing by my calculations) are an accident waiting t happen. Bayer, BASF and Siemens all seem to trade on P/B multiples greater than 2x and have PE10 ratios that are 20x or greater. These multiples require that these stocks need to register strong growth and generate high returns simply to justify these valuations. I would be sceptical that this is achievable.


G&D PE: 13.6x

P/B: 1.07 x

Of all of the markets in Europe, the French index probably has the most depth and breadth in terms of the industries represented. There are twelve stocks with PE10 ratios of 10 or less.

Two are the automobile manufacturers:

Renault: 3.6x

Peugeot: 4.3x

I have never been attracted to automobile companies as an investment. The balance sheets are generally a mess, and returns even with the use of leverage are way too low for my liking.

There are four financials, which is to be expected:

Axa: 8.3x

BNP Paribas: 6.8x

Credit Agricole: 4.5x

Societe Generale: 4.7x

I have no real desire to add to my speculative holdings in financials presently.

Two are construction related:

Lafarge: 7.3x

Bouygues: 10x

I already own CRH plc, but would be minded to add more construction stocks. However, I think that Groupe Bruxelles Lambert (a Belgian listed conglomerate/financial holding company) may be a smarter way into Lafarge.

The remainder are:

France Telecom: 8.1x

Vivendi: 4.8x

Veolia Environment: 6.4x.

Carrefour: 8.4x

These maybe interesting, in tha they are dividend and book value plays as well as having a low thru the cycle PE multiple. However, all are carrying more leverage than I like. Carrefour, may turn out to be interesting. It is certainly worth a closer look. Profitability recently is significantly below what it was in the middle of the decade. I want to take a look to see why this is? There are several companies trading on the Paris bourse that enjoy high valuations, such as LVMH, Pernod Ricard and Groupe Danone, to name a few. These are all high return franchise businesses. Their rating to some degree are deserved given the shape of the returns, balance sheet and profitability. I am not likely to rush out and buy them here and now – but the market is volatile, and some day they may well trade on a lower (& possibly undeserved multiple).


G&D PE: 11x

P/B: 1.17x

To go through each stock in every major index seems like an utter waste of time. I found myself questioning why it was that I put myself through this. The reward is the richness of detail one gleans from even looking at just historical profit, current net debt, most recently reported book value and market capitalisation. Spain has rewarded me for my endeavour. The reward is wariness rather than a rush to invest.

In fourteen years as buy-side equity analyst and investment fund manager I have never come across a market that is as leveraged as the Spanish market is. In general, Spanish companies are up to their eyeballs in debt. If one excludes financials from the index equity calculation, then the remainder of the IBEX index has a debt/equity ratio of  151%. Just to put this into some context, the net debt/equity ratio for the CAC and DAX indices (excluding financials) is 53% and 72% respectively. These figures are calculated using the most recent balance sheet date. (Caveat here is that interim balance sheets may not be audited). Ireland, a country that has had a massive flirtation with debt, is in a situation where the stock market (ex financials) has a gearing ratio of 38%. These are all headline figures. It may well be the case that there are off-balance sheet assets and liabilities that lead to the true calculation being different.

Spain is a massive rights issue waiting to happen in my humble opinion. Either that or it is a great trade on increasing risk appetites in the financial markets.

There is the usual host of Banks, Utilities and Construction companies propping up the valuation tables. The construction sector in Spain is significantly more leveraged than many of the other construction stocks that I have examined. Some of this stems from the concession nature of the revenue stream, but to be candid, the days of that type of leverage are over.

Spain’s Dangerously Cheap Construction Sector

Company P/B Gearing ROE G&D PE
Sacyr Vallehermoso 0.4 285% 8.3% 4.8
FCC 3.2 1053% 51.6% 6.2
ACS 2.0 279% 27.7% 7.3
Acciona 0.8 124% 9.8% 7.6
Ferrovial 1.4 425% 10.9% 12.8

Despite my wariness regarding many of the companies in the index, a few do stand out as being worthy of some investigation.

Company P/B Gearing ROE G&D PE
Mediaset Espana Comm. 1.2 -6% 51% 2.4
Gamesa 0.4 48% 10% 4.3
Endesa 0.9 33% 15% 5.8
Indra 1.6 49% 12% 13.7
BME 3.8 -76% 24% 14.4

Of the financials appearing I am attracted to Banco Popular Espanol on the basis that it continues to have a very high level of pre provision profitability. At some time in the future when the level of provisioning begins to decline (years away at this stage potentially), then this bank could well be one of the banks with the highest Return on Assets in Europe. That alone makes it an interesting proposition.

Spanish Financials

Company P/B Gearing ROE G&D PE
Banco Popular 0.56 1604% 9.9% 5.7
Banco Sabadell 0.64 1622% 8.7% 7.3
Banco Santander 0.67 1722% 8.2% 8.1
Caixabank 0.69 1276% 4.1% 8.5
Bankinter 0.71 2021% 5.6% 8.8
Mapfre 1.09 755.6% 7.6% 12.9


G&D PE: 10x

P/B: 0.77x

The Italian market would appear to offer more value than any of the other national large cap stock indices examined. 

Italian financials are among the cheapest of any that I have looked at (but this has been the case for much of the past three years).

Company P/B Gearing ROE G&D PE
Banco Popolare 0.1 11.6 3.3% 3.8
Banca Monte di Paschi 0.1 15.4 4.5% 2.9
Banca Pop Emil Romagna 0.5 18.4 3.8% 6.4
Banca Pop Milano 0.2 14.2 4.4% 5.1
Generali Ass 1.1 26.9 8.8% 13.0
Intesa San Paolo 0.3 11.6 4.5% 6.8
UBI Banca 0.2 11.8 2.6% 5.9
Unicredit 0.2 15.9 4.7% 4.2

 It should be said that in general, Other than Intesa SanPaolo and Unicreit, many Italian financials are popolare banks. In practice this means that a local municipality holds a stake and the bank is not fully run for profit, but also for the benefit of the locality. Banks in Italy have very very low return on assets due to very very high cost/income ratios. The combination of low leverage and high cost base condemns Italian financial institutions to perpetually low returns versus many other banking systems.

Also, Italian finance is intensely political. There are an intricate web of cross shareholdings and local municipality shareholdings that all vie for their own agenda – more often than not at the expense of shareholders in general. There is no corporate governance culture in Italy that is recognisable to most investors.

That said, many of these institutions now trade at distressed multiples. Unicredit for all of its issue in regards of various exposures trades on a deeply distressed multiple. The rather astute Value and Opportunity has an interesting piece on it at present. I am loath to add more financials, but may simply have to take a look at Unicredit and Intesa SanPaolo. Italian banks entered the financial crisis with lower levels of leverage than many banks in the pan European universe. Despite this they have been amongst the poorest performers (relative to the highly leveraged Nordic banks for example). A salutary lesson for investors here. It is not only the amount of capital that one holds, but the quality of the asset base that capital is supporting.

Of the other companies trading on extremely low multiples, they all have an unattractive returns/gearing profile for me (apart from ENI maybe).

Company P/B Gearing ROE G&D PE
Finmeccanica 0.26 87% 8% 3.3
Mediaset 1.36 132% 23% 5.9
ENEL 0.75 128% 11% 7.0
ENI 1.23 53% 14% 8.9
A2A 0.68 122% 7% 9.5


This has been a tedious exercise, but it has had its rewards. It has revealed a lot to me, particularly regarding the make up of valuation in European equities. When I calculate the PE10 ratio for the European markets I get a ratio of 13.7x.

I will concede that searching for PE10 (Schiller PE or G&D variant) of below 10 times is looking for an extreme condition in terms of valuation. Some of what one finds on these distressed valuation multiples are distressed because they are either going out of business (ie some retail stocks) or that the balance sheets are unsustainable (too many banks fall into this category). I use it as a sanity check in order to find some gold amongst the mud in the hope of maximizing my investment returns.

I have often been baffled that many value investors view value as buying the cheapest securities available without ever asking the question, “Is the overall market conducive to generating high compound average returns from the present level of valuation?”

The proportion to which I invest in equities is in direct proportion to the overall attractiveness of the market in terms of valuation. On the surface of it, the European equity market appears to offer much better value than many other equity markets, in particular the US equity market.

I had a thesis that this value opportunity was actually been driven by the cheapness of the banks, utilities, construction and insurance companies. Outside these sectors there would not appear to be too much in terms of value present. So many of the companies with the types of characteristics that I am seeking in terms of value creation, cash generation soundness of balance sheet are not the ones on very low valuation multiples. (I dont expect companies with sustained high returns to trade on very low multiples in general, but sometimes they might).

I am then left with a predicament.

(i) To invest in value I must in general veer toward banks, construction and utilities/telcos,

(ii) I must relax my view of what is value,

(iii) or I should be patient and simply wait for more high return companies to de-rate to levels whereby they are attractive.

My bias is that I have enough banks (Bank of Ireland plc and Lloyds Banking Group). I will continue to add construction stocks (only have CRH plc at present). After that, I will wait for better valuation support to invest in the equity of higher return companies. Cigar butt investing has never been very successful for me.

ps: I am embarrassed to say that I forgot to look at Finnish equities. I will remedy that when I do a similar piece on Nordic markets.


5 Responses to “Are Eurozone Equities good value (Part 2)”

  1. 1 jmcelligott January 11, 2012 at 9:54 am

    In terms of disclosure I purchased share in Grafton plc and Heijmans NV this morning. Combined purchases now account for 5% of my portfolio. Given the valuation attractiveness of the construction sector, I have decided that it was imprudent to wait any longer to open poitions.

  2. 2 Matteo January 13, 2012 at 8:04 am

    John, I like your blog very much and I’m with you in searching for pure value rather than just the cheapest securities.
    Can I ask you where you get the info for your screening on several markets and companies? More important, is that info reliable? In my experience I almost always have to make some adjustments to reported EBIT and EPS to calculate for example PE10.

    Many thanks

    • 3 jmcelligott January 13, 2012 at 9:40 am

      Hi Matteo,
      I have access to three paid for screens at present, plus a host of free screening tools. The most reliable source takes annual report data in the raw form. For Graham and Dodd PE, I do not use an EPS calculation as the share count may have changed. So I aggregate the sum of of the past 10 years profitability and then use the current market cap.
      On your point regarding reliability. That is an issue – for example, when I was doing this latest batch of screening, I had to chose if there were two Net Profit figures calculated (pre and post exceptionals) which would I choose. I choose post exceptionals. I must concede that during the period under review the accoounting principles changed from natioanl GAAP to IFRS. Thus this is not really an apples for apples comparison. However I have assumed that it will give me a gauge as to where the value is, so I forged ahead.
      Screening technology is an issue for every investor, and this is an area that I may come back to.

      • 4 Matteo January 13, 2012 at 10:23 am

        Thanks very much for your quick reply. Can you mention the three paid for screens and the free ones that you find to be most useful?

        Just to understand, what measure of profitability do you use for G&D PE: (reported) net income? EBIT with some normalisation for interest and taxes?

        On adjustments: you mentioned Carrefour, a company I have been looking at for a long time and still can’t decide if it’s a bargain or the typical value trap/declining business. Over the last decade, there wasn’t a single year when CA didn’t have significant unusual/exceptional/extraordinary items in the P&L, both positive and negative. Some of them might be considered part of the business (for example, income/expenses from opening or closing supermarkets), but others are not. And obviously the analysis should also focus on the quality of the business, not just the cheapness of the stock. But clearly just averaging or normalising reported income will give a distorted view of earnings power.


  1. 1 Market Musings 12/1/2012 « Philip O'Sullivan's Market Musings Trackback on January 12, 2012 at 10:48 am

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