Europe offers added value with substance ("value") shares
Dr. Martin Schlatter, CEFA
Financial Markets
In October 2021, the inflation rate in the U.S. exceeded 6% for the first time in decades; the result was a significant rotation on the stock markets. Inflation fears have erupted and redirected expectations: To curb inflation, central banks would have to completely change their policies, away from low interest rates and generous money supply expansion to rising interest rates.
In October 2021, the inflation rate in the U.S. exceeded 6% for the first time in decades; the result was a significant rotation on the stock markets. Inflation fears have erupted and redirected expectations: To curb inflation, central banks would have to completely change their policies, away from low interest rates and generous money supply expansion to rising interest rates.
The consequence: Growth stocks are out, value stocks are in. Thanks to a lower valuation, substantial cash flow and less stressed growth rate expectations, value stocks typically yield better as soon as interest rates rise.
When looking for value stocks, investors find them mainly in Europe. The chart below shows why. The price-to-book ratio of the North American equity market has only increased since the financial crisis compared to Europe. On average, North America has been about 1.5 times more expensive than Europe (middle dashed line). Currently, North America is about twice as expensive as Europe.
Price/book ratio Europe vs. North America
Preis/Buch Europa ggü. Nordamerika
Since the financial crisis, however, the price/book value has not been entirely uncontroversial. This is because financials typically have a low price/book value and optimize it to some extent with off-balance sheet positions. Therefore, the average value in the graph (middle dashed line) is 1.5. With a weighting of financials of 12% in North America versus 18% in Europe, Europe may be cheaper. Therefore, the average value is 1.5.
Let's look at another criterion, the enterprise value in relation to earnings before interest and taxes. Here, too, it can be seen that companies in the USA have become increasingly expensive, currently costing around 30% more per profit before taxes and interest.
Enterprise value / earnings before interest and taxes
EV/EBIT
These two charts suggest that there is currently more value to be discovered in Europe than in the US. Therefore, investors who expect rising interest rates and thus want to bet on value stocks should increasingly focus on Europe.
Does Value pay off in Europe? The chart below shows various style portfolios in Europe compared to the index. Of course the period is very short since the beginning of December, but the better return of Value (orange line) is clearly visible.
Style Portfolios in Europe
Style Portfolios in Europe
