Is the market overly pessimistic about growth in Europe?

Is the market overly pessimistic about growth in Europe? This guest post from Sridharan Raman from Thomson Reuters discusses the economic growth and value in Europe.

The economy in Europe is finally showing signs of life with major players France and Germany coming out of the recession. When these economic drivers show signs of growth, the rest of the region is likely to follow suit.

However, another question must be asked: are hopeful economic signs good for European stock markets? Have stocks factored this into prices already or is there still value in investing in the region? Thomson Reuters StarMine aggregates various measures by regions. In specific, we look at large and mid- cap companies, use the current stock prices and solve for expected growth using the StarMine Intrinsic Value (IV) model (a dividend discount model). We see that despite the uptick in the European economy, stocks are priced for negative earnings growth (earnings shrinking) over the next five years.

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Analyzing growth prospects

In the table below we see that the market implied growth rate for emerging Europe is the lowest at -12.2%. To put that in perspective, the growth rate required to justify current stock prices in emerging Europe is -12.2% every year for five years. That’s the lowest for any region around the world, with the second lowest market implied growth rate being for developed Europe. So how do those market implied growth rates compare with the expected growth rates? StarMine intelligently adjusts for analyst optimism and pessimism biases and comes up with a five-year SmartGrowth rate of 3.2% for emerging Europe. The differential of 15.4% between the market implied growth rate and the SmartGrowth rate is the largest of any of the regions. Combine that with the highest dividend yield of 4.6% for emerging Europe and it indicates that there may still be some value in this region’s equity markets, relative to growth expectations.

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Source : Datastream Pro/StarMine

Discovering value

As you can see, for North America, the market implied growth rate and the SmartGrowth rate differ by just 2.6%. That means that most of the expected growth rate of 7.9% may be priced into the equities. Developed Europe on the other hand has a bigger differential of 6.2%, and has a higher dividend yield of 3.2%, so may have more value. Despite the low expected growth rates in Europe, the even lower market expectations may be a source of value in the region. If the uptick in the economy holds, then the expectations for growth may improve further. In fact, of all the regions, emerging Europe has the largest Predicted Surprise, which means that the latest and the best analysts have estimates above the consensus. That’s an early indicator that estimates may be on the rise, which means that growth rates may also go up. That will only widen the differential between market implied growth rate and the SmartGrowth rate, unless equity prices increase to narrow the gap.

By Sridharan Raman,Thomson Reuters Senior Research Analyst

Thomson Reuters

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