5.7.2024
Article

High but treacherous discounts at summer Solden at the fair

European stock markets have rarely been so discounted relative to U.S. ones, and small- and mid-cap stocks rarely so cheap relative to megacaps. But far from all bradeer prices are interesting. How do you pull prepared for seasonal sales hunting?

It will probably sound familiar to bargain hunters. Tempted by a high discount on the new price, you buy that one dress or that one shirt, while the fabric or the cut is not quite right and you have no idea how to combine the pattern. Result: the garment stays in your closet, is ballast in your wardrobe and you don't enjoy it. Cheap is often not the best buy on the stock market either. As tempting as some discounts may seem, they are often there for a reason.

And those reasons can be diverse. An undervaluation of a company relative to its own long-term averages or relative to industry peers can result from financial difficulties, management problems, loss of market share, or other weaknesses that cannot be easily or quickly resolved. Elements outside the company's control can also have a long-term impact on valuation, such as recessions, inflation, or rising interest rates.

Currently, stock market discounts are much higher than usual in large chunks of the market, so time to take a closer look at that phenomenon. We sought out the most discounted Belgian stocks, based on several parameters: their price-earnings ratio, market value relative to book value, discounts on their underlying assets and the level of gross dividend yield (see table).

'Eternal discount'

The largest, most persistent and most often cited "supersoldier" is that of Europe relative to the United States. European stocks have historically traded at a lower price-to-earnings ratio than U.S. stocks. That means investors in Europe pay less for every euro of profit a company makes, compared to what investors in the U.S. pay for every dollar of profit.

There are several reasons for that contrast. Europe has suffered slower economic growth and political uncertainties in recent years, such as brexit and the eurozone debt crisis, while the U.S. economy has grown much more strongly. The U.S. stock market also has greater exposure to fast-growing, global technology companies, which often command higher valuations. Europe has many companies operating in finance and energy, sectors that traditionally have lower valuations.

Although the European discount has been in place for many decades, it is now significantly higher than usual. European stocks now trade at an average price-to-earnings ratio of 12, versus 20 for their U.S. sector peers. That makes them 40 percent cheaper, versus an average discount of "only" 25 percent over the past 15 years.

Much has to do with the giga valuations of large U.S. tech companies that are snatching away all investor attention. To illustrate, the stock market value of chip giant Nvidia has become larger than that of the entire French, German or British stock market (see chart). Super companies like Nvidia, Apple, Microsoft, Alphabet and Amazon put the rest of the market in the shade.

This has also widened the gap between the top tier and the broad market in the US. Companies in the U.S. small-cap index Russell 2000 have a price-to-earnings ratio below 16, even though they averaged 12 percent revenue growth per year over the past three years. That's exactly the same as companies in the S&P500, which houses the largest 500 U.S. stocks, for which you pay 20 times earnings.

'We are in a sandcastle economy that works on two tracks,' said Peter Garnry, Saxo's chief strategist. 'A handful of booming sectors, such as AI, defense and obesity medicine, stand out against other sectors that barely get any attention.'

'Despite the exuberance in the U.S. thanks to leading AI companies, we think European equities will excel in the period ahead, driven by the European Central Bank's interest rate cut in June and a growth recovery in the third quarter,' Garnry continued. Energy, healthcare, banking and IT are in his favored European grab bag for summer bargains.

'We are mainly buying into the UK and Spain,' says Wouter Verlinden, who manages a fund of small- and mid-cap European stocks at Ghent-based asset manager ValueSquare. 'Those are two interesting markets with very depressed valuations. So is France to some extent, but there the problem is that the companies are often very domestically focused. That's a vulnerability. In Spain and the UK, we see very internationalized companies. Those include a lot of dollar earners, or companies with exposure to growth in Latin America.'

Spain and the UK are two interesting markets with overly depressed valuations.
- Wouter Verlinden
Fund Manager Value Square

'I think France is worth exploring, after the downgrades in recent weeks,' said Guy Sips, the small-cap analyst at KBC Securities. 'The gap between the German DAX and the French CAC40 has become above average.' Sips mentions, among others, Bonduelle, a vegetable producer that is trading below its book value after recent price weakness. 'You can see that Belgium's Greenyard has come down with it. The bad weather is a factor there, but you can ask whether that kind of reaction is excessive.

In the Benelux, many companies are struggling with distrustful investors who see the glass half-empty. 'Several Belgian companies indicate in their guidelines that they are back-end loaded, in other words that the second half of the year will be better than the first,' says Sips. 'But you see that investors don't believe that today.

The KBC Securities analyst cites Kinepolis as examples. 'Those companies are in the same negative narrative. Investors want to see proof first. So with their half-yearly figures it is particularly important to watch the outlook they give,' says Sips. If they are better than expected, the market can see that they have been too negative.

In the summer, small investors have additional opportunities to capitalize on anomalous price declines.
- Wouter Verlinden
Fund Manager Value Square

Summer is the best time for retail investors to study discounts and undervaluations, Verlinden says. Professional investors are on vacation then, and investment committees at fund houses and asset managers are not making big decisions. 'At the same time, funds do have to sell in the summer when there are outflows, with no buyer at that time, perhaps. That gives small investors an advantage to capitalize on anomalous price declines. They never take a vacation (laughs).'

Caution always remains the order of the day. "In recent months, buying at discounts has not produced the desired results because the market's focus is so one-sided," Verlinden says. When will that reverse? 'It ebbs and flows. If tomorrow the AI craze subsides, that will change. But you can't predict it.'

Read the further article via De Tijd: High but treacherous discounts at summer sell-offs at stock exchange

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