Can European Stocks Continue to Grow Earnings?

The outlook for European equities look positive - as long as companies can continue to grow earnings

Clémence Dachicourt 3 April, 2018 | 9:55AM
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Mario Draghi European Central Bank quantitative easing monetary policy

European equities have underperformed US equities by 63% since the end of 2007 on a real total return basis. Over this period European earnings per share declined by 52% relative to their US counterparts – impacted most noticeably in mid-2011 as the Eurozone crisis broke out.

Since then, European companies have seen their earnings decline by 21% which compares to a 14% increase in the US. It was not before the middle of 2016 that the European Central Bank’s aggressive monetary policy started to reverse this trend and kick-start a recovery in company revenues.

2017 was the first year of positive earnings growth for European equities in a decade. Consensus expectations are also pointing for another solid year in 2018. Whilst energy and financials were the main growth drivers twelve months ago, overall sector contribution looks to be much broader this year.

Without pointing to undue optimism investor positioning, sentiment indicators and valuation levels clearly reflect a large portion of this good news. Fund flows into European equities have been positive since early 2016 leaving investors with an overweight position: the composite fund’s European equity beta currently sits towards the upper part of its 10-year range.

After several years of multiple expansion, European equities now trade on 15x 12-month forward earnings – slightly below their long-term median. Going forward the asset class will therefore remain dependent on the capacity of European companies to grow earnings and outpace analysts’ expectations.  

The broader earnings outlook remains reasonable; the consensus expects eps and sales to grow by 8,8% and 3,8% respectively in 2018, particularly so for cyclical companies that benefit from a higher operating leverage. However, one needs to acknowledge that the ECB is now in a tapering mindset. German Bunds are too rich, and spreads are tight so there will be a point when central bank tightening will raise financing costs and affect overall market liquidity which would advocate for more selectivity and solid portfolio diversification.  

Many European cyclicals currently offer a very low to negative margin of safety. Although we still like European financials and energy we would mitigate that cyclical bias with more defensive sectors such as pharmaceuticals.

A version of this article was published in Investment Week

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Clémence Dachicourt  is Senior Portfolio Manager for Morningstar Investment Management

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