STRONG EUROPEAN EARNINGS ARE KEEPING EUROPE CHEAP
Burt White Chief Investment Officer, LPL Financial | Jeffrey Buchbinder, CFA Market Strategist, LPL Financial
After years of diminished earnings ended in the third quarter of 2016, European companies have begun seeing sustained growth in their bottom lines. Ultimately, earnings drive stock prices, but the market is always trying to look forward; having strong earnings is not enough if the growth is fully priced in. That is the fundamental question with regard to stock market valuation — what are you paying for future earnings? Solid earnings in Europe are keeping price-to-earnings ratios (PE) static, while PEs on domestic stocks have been rising. This makes European equities increasingly attractive; however, currency remains a concern, as much of the recent performance of European stocks has been due to a strong euro relative to the dollar.
IT’S WHAT YOU PAY THAT COUNTS
Two things determine stock prices: how much money a company earns, and the multiple of those earnings investors are willing to pay, i.e. the PE ratio. When we consider international investments, we have to be careful when comparing the PE ratio of one country’s or region’s stock market to another. For any number of reasons, some countries could systematically trade at higher or lower valuations than others. From the early 2000s until the beginning of the Great Recession, European stocks were consistently cheaper than U.S. stocks based on their PE ratio [Figure 1]. As the economy and financial markets recovered, U.S. and European stocks begun trading at nearly the same valuation.....