What’s Not to Love?

As an investor and observer, I am surprised—or should I say astounded—at the following NEWSWEEK cover story and the argument and statistics it cites. As you'll read in the pages ahead, Europe's top companies have beaten America's (and Japan's) hands down over the last decade when it comes to increasing profits, revenues, and global sales. It's an idea with newsy importance, given new industrial-production numbers showing that the recovery from the financial crisis in Europe actually began much sooner, and was stronger, than we first thought. The figures are a game changer, particularly for Germany; the world may need to rethink the caricature of ossified Europe.

The gap between conventional wisdom and reality here is wide—so wide that there is an opportunity for savvy investors. Consider the consensus economic-growth forecasts for the United States, all of the euro area, and specifically Germany (worth noting because it is the largest and arguably the most dynamic continental economy). The U.S. is expected to grow by 3 percent this year, compared with 2 percent in Europe and 2.1 percent in Germany. For 2011 the estimates are 2 percent, 1 percent, and 0.6 percent, respectively. All such numbers should be viewed with many grains of salt. Yet the general view of the market people of the world is clear: growth will be significantly lower in Europe this year and next than in the U.S., and inflation will be higher. What's more, the European economies had a deeper recession in 2008 than the U.S.

On April 15 The Wall Street Journal ran a story headlined EUROPE IS FAILING TO KEEP UP, arguing that while other major parts of the world were recovering, Europe was stagnating. The continent was cited as the biggest drag on global growth, with ailments ranging from a declining population and uncompetitive wages to a lack of confidence. "The short-term outlook for Europe is distressingly bleak," the article concluded, adding, "Debt-burdened Greece is not the problem. It's a symptom." If the dark souls are right that the world is on the brink of a sovereign crisis, then Europe is in the eye of the storm.

These rather sour assumptions are clearly incorporated in equity-market valuations. For example, European companies sell at 12.7 times this year's earnings and 10.5 times next year's, in contrast to U.S. equities, which trade at 14.7 and 12.2 times, respectively. Translation: European stocks are cheap compared with American ones. What's more, European stocks pay average dividends of 3.4 percent, versus 1.9 percent for American equities. The price-to-book ratio, a measure that I consider the best long-term benchmark of value, is 1.7 times for Europe, versus 2.2 for American equities (lower ratios equal better value). It's no wonder that the Merrill Lynch fund managers' survey indicates the world's institutional investors are more likely to underweight Europe in their portfolios than any other region. Europe is underowned and undervalued.

The point of all this is simply to say that the assertions of the following essay run very much counter to the "wisdom" of the crowd, and that many of the facts cited are not yet recognized in the markets. This will likely change soon—the recent announcement of a $50 billion loan for Greece from the EU in exchange for stricter enforcement of budget-deficit targets (not just in Greece but across the board) means that Europe's sicker countries will have to improve their competitiveness and vital economic statistics. This could mean lower inflation and, ultimately, healthier economies. But if this article is right, Europe is already an undiscovered investment diamond in the rough. The world should rethink its stereotypes.