Taking stock of Europe: Is now a good time to invest?

While many investors are shying away from Europe because of uncertainty over the eurozone crisis, others believe the valuations of European stocks offer stock-picking opportunities relative to emerging markets, the US and the UK.

But the range of valuation standards available can make it confusing for investors to decide which metric to use. These range from price/earnings (p/e) ratios – the value of a stock as a multiple of its earnings – to price/book (p/b) – the value as a multiple of tangible assets minus liabilities – to dividend yield or return on equity (RoE). The question of whether to use consensus estimates or trailing figures for earnings, dividends and the like makes matters even more complicated.

Looking at p/e ratios based on the Institutional Brokers’ Estimate System (IBES) aggregates – consensus forecasts – the estimate for 2012 is that Europe will be operating on a p/e of 9.5 times, which is the same for the UK, slightly higher than Germany and well above the 8.9 times from France.

On this basis the valuation of Europe as a whole looks cheaper than, say, the US S&P 500, which has a p/e estimate of 12 times for this year, while Asian emerging markets has a figure of 10 times.

The figures also place the Europe-wide p/e ratio below the 11.1 times of the MSCI World (Developed Markets) index, the 10.5 times of the MSCI All-Country Asia Pacific excluding Japan index and well below the 11 times p/e ratio of Japan.

However Europe is still not as ‘cheap’ as, say, Russia, which has a p/e consensus forecast of 4.8 times for 2012, or the 7.9 times p/e for Turkey.

On a p/b basis Europe also looks relatively cheap compared with most major markets. It has an overall ratio of 1.4 times, which is below the 2.1 times of the US S&P 500 and the 1.6 times p/b of emerging markets as a whole, but is actually more expensive than Japan, which has a p/b of 0.9 times.

This can partly be explained by the fact that the UK has one of the largest equity markets in the world, so the Europe p/e estimate can be quite skewed by the UK’s inclusion, while many of the companies listed in the UK are global. To a certain extent this is also true of Germany, which has a number of major exporters. The Europe p/e therefore also reflects global earnings.

Frances Hudson, investment director and global thematic strategist for Standard Life Investment, points out that because there are so many metrics there is a tendency for people to use the metrics that suit their purpose or give them the answers they want to convey.

“The idea that you can actually get an investment signal that’s worthwhile – for example, that if the p/e reaches a certain level it triggers a buy signal, or if it reaches a certain level it triggers a sell signal – I think is a little naïve. Even if it did revert to a mean, which is what that kind of argument is based on, it could be out of kilter for a number of years, so you’d still need some kind of trigger to make it move back.”