FIVE BEST EUROPEAN STOCKS LIST

Years after the financial crisis swept across the world, Europe is ripe for investors. After 18 months of economic contraction, the euro zone, the 18 nations that officially adopted the euro as their common currency, finally emerged from recession last year.

Although Kiplinger’s expects another winning year for U.S. stocks, there’s a reasonable chance that European shares will do better (see “Outlook 2014” and “Investing Abroad: A Mixed Bag,” Jan.). The Federal Reserve has already started to scale back its bond-buying program, which has kept long-term interest rates low and which many analysts say has played a key role in levitating share prices in the U.S. The European Central Bank (ECB), which oversees a number of economies that are weaker than the U.S.’s, is likely to maintain more-  stimulative policies for a longer time, and that will be a key driver of European share prices, says Alec Young, a global equity strategist at S&P Capital IQ.

European stocks are also cheaper than their U.S. counterparts. The average European stock trades at 13 times estimated 2014 earnings, compared with a price-earnings ratio of 15 for U.S. stocks. (All prices are as of December 31.)

Despite improving economic data, Europe is hardly booming. Kiplinger’s expects gross domestic product in the euro zone to grow just 1% in 2014. The unemployment rate in Spain is a staggering 26%. Greece, with outstanding debt at 160% of its GDP, will almost certainly not be able to repay all it owes. Political turmoil in Italy may undermine that country’s fragile economy. But the overall recovery in Europe, though modest, is real, and lagging nations are expected to make up ground over the next few years.

Below we list five European stocks that should benefit from the blossoming recovery. Symbols and share prices are for American depositary receipts (ADRs). If you’d prefer to invest in Europe through a fund, you’ll find our best bets in the box on page 34.

Financials recover. The 2008 crisis hit the European financial sector hard. Many banks held sizable amounts of government debt from the troubled euro zone countries. Banks failed, and bailouts were needed. But the financial system in Europe has come a long way over the past few years. Government bond yields have stabilized, the European Union continues to enact banking reforms, and the ECB is holding down interest rates to promote growth. Two banks that should prosper are LLOYDS BANKING GROUP (SYMBOL LYG)and BANCO SANTANDER (SAN).

Lloyds, one of the most venerable banking names in the United Kingdom, might have fared better during the global meltdown had it not bought HBOS, a troubled British firm with interests in banking and insurance. The deal was announced in September 2008, just two days after Lehman Brothers filed for bankruptcy, a key event in accelerating the financial crisis. Lloyds’s ADRs, which traded at $48 in early 2007 and $19 when the deal was announced, plunged to less than $3 after the takeover was completed in January 2009 and ultimately bottomed at $1.34 in November 2011. After the British government bailed out Lloyds with several cash infusions, the company did some damage control of its own. It closed the worst of HBOS’s businesses and wrote down billions of dollars in bad loans.

Lloyds appears to be on the mend. Its business is concentrated in the U.K., where the economy and housing market are strengthening. (The United Kingdom is a member of the European Union but does not use the euro as its currency.) Lloyds, which lost money in 2012, was expected to have earned 36 cents per ADR in 2013, and analysts see profits of 42 cents per ADR in 2014. At $5.32, Lloyds sells for 13 times estimated 2014 earnings, in line with the average P/E for the financial stocks in Standard & Poor’s 500-stock index.

Banco Santander, the largest bank in Spain, made it through the global recession relatively unscathed despite the significant, and lingering, damage to the Spanish economy. It helped that the 156-year-old bank diversified outside of Europe decades ago and has become a major institution in global banking. Latin America—particularly Brazil and Mexico—now accounts for 50% of Santander’s profits. Europe accounts for about one-third of the bank’s profits, with half of that coming from Spain. Santander posted strong results in the third quarter of 2013, and analysts see earnings growing by 20% in 2014, to 67 cents per ADR.

The ADRs, at $9.07, are nearly 60% below where they stood in October 2007. At 14 times estimated 2014 earnings, Santander is reasonably priced.

Consumer comeback. Better European economies should encourage the Continent’s inhabitants to spend more on the finer things. We like two companies that should benefit from Europe’s rising consumer spending.

ELECTROLUX (ELUXY), one of the largest household-appliance makers in the world, remained profitable through the financial crisis. More recently, the Swedish company, which gets nearly one-third of its earnings from North America, has been benefiting from the U.S. housing recovery. Business in Europe, which contributes about20% of profits, is expected to grow over the next few years. Electrolux is known for its namesake vacuum cleaners, washers and dryers, as well as its Frigidaire refrigerators.

At $53, Electrolux trades at 14 times estimated 2014 earnings, in line with the P/E of rival Whirlpool (WHR). Andre Kukhnin, an analyst with Credit Suisse, rates the stock a “buy” and sees it rising 13% over the next year. (His price target is based on Electrolux’s Swedish-listed shares, which are priced in kronor.)

Spanish fashion retailer INDITEX (IDEXY)operates more than 6,000 stores worldwide. Globetrotters can find its flagship chain, Zara, in almost every major city in the world. The core market for Inditex is Europe, which accounts for two-thirds of sales, but the company (formally called Industria de Diseño Textil) is also expanding into emerging markets. Highly regarded for its expertise in “fast fashion”—the ability to rapidly design, produce and distribute trendy-yet-affordable clothing—Inditex will surely profit as Europe picks up steam.

Raymond James analyst Cedric Lecasble believes the company will outpace the broad European market over the next 12 months. At $33, the ADRs sell for 26 times estimated year ahead earnings. That is in line with Inditex’s biggest competitor, Sweden based Hennes & Mauritz (HNNMY), otherwise known as H&M.

Impressive income. As U.S. investors know, phone companies are go-to stocks for dividends. The same is true in Europe. In particular, the ADRs of DEUTSCHE TELEKOM (DTEGY), the Continent’s largest telecommunication services provider, yield a juicy 5.4%, more than both AT&T (T) and Verizon Communications (VZ).

Deutsche Telekom is a company undergoing change. It has a new CEO, and it has been negotiating to sell its T-Mobile USA subsidiary (it owns 74% of the company). Sale of the unit would probably net the German company about $15 billion before taxes and allow it to focus on its European operations, which currently account for 80% of earnings.

With revenues having climbed 6% in the third quarter of 2013, Deutsche Telekom is showing signs that it is benefiting from Europe’s recovery. The ADRs, at $17, aren’t cheap for a telecom stock, trading for 18 times estimated 2014 profits. But analysts see Deutsche Telekom’s earnings jumping 26% this year, so the above average price-earnings ratio seems defensible. Plus, even if the stock does nothing over the coming year, you’ll collect that handsome dividend

ANJELICA TAN

WALL STREET: ANOTHER GOOD YEAR FOR U.S. STOCKS CONTRARIANS SEE RISKS FROM STRETCHED VALUATIONS, INFLATION AND THE FED

Bank strategists agree:   U.S. stocks are going up in 2014, at least a bit. At the beginning of January, after the Standard & Poor’s 500 Index closed out 2013 at 1,848, their end-of-year targets ranged from 1,850 to 2,100. The median among 20 sell-side prognosticators was 1,950, which would be a 5.5 percent gain if it pans out. In other words, after big advances for U.S. stocks in four of the past five years, including a robust 32 percent return for the S&P 500 last year, the forecast is for more.  

What could possibly go wrong? Fortunately, there are always a few money managers and strategists ready to address that question. Their present concerns encompass inflation, Federal Reserve tapering, stock valuations and technical chart breakdowns. 

David Rosenberg, chief economist at Gluskin Sheff & Associates Inc., says the biggest stock market risk right now is that the Fed will be forced to raise interest rates as the economy grows faster than expected. That flies in the face of current wisdom. While the Fed has begun to withdraw its monetary support for the economy by trimming its bond purchases, most economists say the central bank will keep its benchmark funds rate near zero at least into 2015.  

A market that shrugged off bad news for the past several years may quickly become one underwhelmed by good news, in Rosenberg’s thinking. “One thing that we learned in this cycle is that you can have very weak growth but a tremendous surge in the market when the Fed is providing a tremendous amount of liquidity,” he says. “I’d expect that when we actually get growth, and we get the Fed doing something different, we’re going to get different results in the market.” 

Jim Paulsen, chief investment strategist at Wells Capital Management in Minneapolis, describes a scenario that has a lot in common with Rosenberg’s. Inflation, or inflation fears, is a possibility in 2014, Paulsen says. He sees nominal economic growth accelerating to as much as 6 percent with gross domestic product expansion at 3.5 percent plus inflation, measured by the GDP price deflator, up to 2.5 percent.  

The threat of an overheating economy would then raise concern that the Fed will be unable to withdraw its extraordinary monetary support in an orderly fashion, Paulsen says. “The methodical and well-controlled monetary tapering which greets us here at the beginning of the year could turn to a ‘panic taper,’” Paulsen wrote in a Jan. 2 letter to clients. That would wreak havoc in the bond market, and    boost stock market volatility, he says.  

Paulsen forecasts that the S&P 500 will climb as high as 2,000 at some point in 2014, a gain of 9 percent from when he published his note, and then slide, finishing with no gain at all for the year. If that comes to pass, it likely would be a setback and not an end to the bull market, which he says has more years to go.  

Sam Stewart, chairman of Wasatch Advisors Inc. in Salt Lake City, predicts a rapid stock market sell-off at some point in 2014. He argues that stock valuations are stretched after the five-year bull market, especially when rising price-earnings ratios are compared with slowing growth rates the so called PEG ratio. Based on profits and profit growth for the most recent 12 months, the S&P 500’s PEG ratio was    3.1 at the beginning of the year, compared with a 20-year average of 1.1, according to Stewart. That’s higher than it was in 2007, when the market touched its pre-financial-crisis peak, he says. 

price earning ratio
source : yale university

If stocks are expensive, they’re vulnerable to unpleasant surprises, Stewart says. The nationwide steel strike in 1959 and the failure of Long Term Capital Management in 1998 are examples of events that triggered selloffs in overvalued markets, according to Stewart, whose Wasatch World Innovators Fund beat 99 percent of its peers during the past five years.  

For Carter Worth of Oppenheimer & Co., the New York investment bank and wealth manager, the big risk may be simply that total returns for U.S. stocks have been positive for five years running. Worth is his firm’s chief market technician, meaning his forecasts are based on historical charts and patterns, not economic or company fundamentals.  

Since 1927, the S&P 500 has had five consecutive winning years on six previous occasions. The average return in the next year was negative 2.3 percent, according to Worth. And the peak-to trough decline in that sixth year, as opposed to the calendar year move, averaged 23 percent. “At a minimum, 2014 has high odds to be a below-average year,” Worth says, “with the possibility that it’s not only below average but has something quite ugly.”