European Stocks to Buy When Europe Bounces Back

Greece has (maybe) agreed in principle to reform its tax and pension systems in exchange for a new three-year loan from the eurozone’s bailout fund. I say “maybe” because Prime Minister Alexis Tsipras has given no indication of what those reforms might look like, and as recently as today was still insisting that some amount of debt relief be included — something that Germany has ruled out.

Stocks in Europe

Source: Dbachmann via Wikimedia commons

Meanwhile, the European Central Bank stands ready to pull the plug on the Greek banking system, Greece is as close as it has ever been to an actual Grexit, and Tsipras has yet to wear a proper necktie in any of his press conferences or official meetings.

In any event, the Greek drama will soon reach its tragic end. Either Tsipras will agree to reforms that may or may not get enacted, or he won’t and Greece will end up getting ejected from the eurozone. Either way, we should know by the end of this week, and the uncertainty surrounding Europe should be close to resolved, as least for now.

I’ve been bullish on European stocks for the past year based on their vastly cheaper valuations relative to the American market. I’m not quite willing to jump into the Greek market just yet, as there aren’t many liquid stocks to choose from, and those that are available aren’t quite as cheap as I’d like to see, given the macro risk. But, European stocks as a whole are a fantastic bargain, and the recent selloff presents a great buying opportunity.

Here are a few ways to play the coming rally in European stocks:

European Stocks to Buy When Europe Bounces Back — Vanguard FTSE Europe ETF (VGK)

I’ll start with a broad play on developed Europe, the Vanguard FTSE Europe ETF (VGK).

VGK gives you exactly what you want from a Vanguard index fund: instant diversification, tax efficiency and rock-bottom fees. VGK holds a basket of 540 stocks spread across the major economies of the eurozone, as well as non-eurozone countries Norway, Switzerland, and the United Kingdom. As a passive index investment, VGK only turns over about 7% of its portfolio per year, and its expense ratio is a negligible 0.12%.

VGK’s largest country weighting, at 31%, goes to the United Kingdom. France, Germany and Switzerland each chip in 14%, and after that the weightings trail off. “Problem children” Spain and Italy make up only 5.2% and 3.7%, respectively. Looking at industrial sectors, VGK has a pretty conservative bent. About half the portfolio is invested in financials, health care and consumer staples.

If you’re looking for instant exposure to the major markets of Europe, this is it. But, if you’re looking to play a rebound in the markets hardest hit by the Greek fiasco, you might find that VGK is a little too conservative.

European Stocks to Buy When Europe Bounces Back — iShares MSCI Spain ETF (EWP)

For more aggressive investors, my next recommendation is the iShares MSCI Spain ETF (EWP). There are relatively few Greek stocks that trade as ADRs, and any investment in Greece should be viewed as a coin toss in this environment: Heads, Greece stays in the eurozone and Greek stocks rally; tails, we get a Grexit and Greek financial assets drop by another 50% or more. The returns potential is huge, but there is simply too much downside risk for me to get comfortable.

Spain, however, represents a nice risk/reward trade off. While Greece’s economy remained depressed, the Spanish economy is expected to grow 2.8% this year. Regional unrest is a problem, and Catalonia may very well push forward with a referendum on independence. Spain has had regional unrest since the Franco dictatorship, yet life seems to have a way of moving on.

Looking at Spanish stocks, there’s a lot to like. By Research Affiliates estimates, Spanish stocks trade at a cyclically-adjusted price/earnings ratio (“CAPE”) of just 12, which is less than half the CAPE valuation currently being sported by American stocks.

Spanish stocks also have relatively little exposure to the Spanish economy. Spanish multinationals are active across Europe, and taking advantage of common language and cultural ties, they also have an outsized presence in Latin America.

EWP gives a nice basket of Spanish stocks, including household names like Banco Santander (SAN), Telefonica (TEF) and Zara’s parent company Inditex (IDEXY).

European Stocks to Buy When Europe Bounces Back — Daimler AG (DDAIF)

Finally, let’s drill down to an individual stock that I expect to perform very well: German luxury automaker Daimler AG (DDAIF).

Traditional auto stocks have been out of favor of late, as investors have flocked to sexier growth stories like Tesla Motors (TSLA). Yet, at current prices, Daimler offers a value that is hard to ignore. DDAIF stock trades hands at just 10 times earnings and sports a dividend yield of 3%.

Furthermore, after lagging its German rivals for years, Daimler has done a nice job playing catch-up with a redesigned product lineup.

If China’s market rout slides into a real “hard landing,” Daimler will feel the pinch, as China makes up a good 13% of revenue. Yet, as recently as last month, Daimler announced that it expects to see sales growth of at least 10% this year in China.

Daimler is a solid company trading at a cheap valuation. It’s a buy on any continued Greece-related weakness.

As of this writing, Charles Sizemore did not hold a position in any of the aforementioned securities.

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