On Europe’s lower multiples

It’s only fitting that I write something today on Europe’s multiples since I wrote yesterday on P/E multiples in the US. What prompted this were two different articles, one on Europe’s lower multiples in general and the second on a Spanish retailer.

Let’s look at the Spanish retailer first. The BBC writes:

Zara-owner Inditex, the biggest fashion clothing retailer in the world, has reported yet another increase in profits, helped by sales in Eastern Europe and its new online store in China.

Profits rose by more than 22% to 2.3bn euros ($3bn:£2bn) in 2012.

The results narrowly missed analysts’ high expectations, and shares were down more than 3% this morning.

The company also announced plans to open more than 440 stores in 2013.

Although its fourth-quarter performance was slightly weaker, “looked at on a full-year basis, the results are clearly very strong,” says Nomura research analyst Fraser Ramzan.

“It’s a stand out performance relative to any mass market retail business in Europe.”

I have mentioned this stock before. Back in a June daily commentary, I wrote that Inditex is a retail stock worth watching. Back then, the stock had just jumped from trading lows of around 65 euros and now Inditex is trading near 52-week highs of 11.80 euros. It’s P/E ratio is pretty high now too at 28 times trailing earnings. So the stock is not much of a bargain anymore. However, it does highlight the fact that just because a company is domiciled in a country in dire straits like Spain doesn’t mean it can’t be a good deal. That’s the first article.

The second article was on Jim O’Neill’s worries about the recent stock market rally in the US and it showed a good chart from Goldman on European versus US multiples. The chart shows the US trading at a cyclically adjusted P/E of 23.6 times, the highest on the chart along with Mexico and Japan (one reason to think the Japanese equities rally may now be nearer the end than the beginning – but that’s another story). In contrast, Spain was selling at 7.0 times and Italy was selling at 7.3 times. Even Germany was only trading at 13.4 times earnings.


Now, we are talking multiples here, which should make markets comparable. And the differential is enormous. Clearly, the US is in a recovery and Europe is not. But the point here is that these multiples are based on a business cycle-type average over multiple years. And what the differential is telling you is that Europe continues to be extremely cheap compared to the US. Over the medium- to long-term, Europe should outperform just on this measure alone.

What this goes to show as well is that not only do earnings expand and contract with the business cycle, multiples expand and contract with earnings according to market sentiment to give the market a double whammy lift or wallop. Europe’s earnings are depressed and their multiples as well, as one would expect in a bear market. We should expect that once the bear market is over we will see huge multiple expansion from these extremely depressed levels, especially in countries like Spain and Italy. The right thing to do is to start looking for value there. Inditex was one call in June. Now it is no longer undervalued. There are a lot more examples though. You just need to look around.

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