The value investor has become something of a dying breed over the past decade, pushed away from a market obsessed with the pursuit of endless growth in areas such as technology.
The underperformance of the value style of investing has been widely discussed and, barring a relatively short rally this year, is especially painful for deep value investors, such as us at within Schroders’ value investing team.
The result is a wide chasm in the valuations of the cheapest and most expensive stocks.
This did not go unnoticed. Indeed, one of our favorite columnists in the FT last week, Robert Armstrong, said “value stocks look like heck of a value right now!”. He pointed out that the price-to-earnings multiple of growth and value stocks in the United States was now at a 20-year low.
It’s true and compelling. But there is one place where the differential is even more pronounced: Europe. And what is most surprising is that – against all odds – Europe’s cheapest companies have seen higher earnings growth than Europe’s most expensive companies.
Here are three paintings that tell the story.
The first examines the dispersion of valuations between growth and value in Europe, using data from Morgan Stanley which combines three valuation measures: price/earnings (P/E), price/book value (P/BV) and price/dividend (P/Div).
While the similar value gap in the US is undoubtedly cheap, the data in Europe is mind-boggling. Europe has sunk below the dotcom nadir at the turn of the century and the recent rebound still leaves a very long way to go.
Valuations of value versus growth are still near all-time lows
While this is the relative case for value in Europe, let’s not forget the absolute case. Taking the MSCI Europe indices as a direct proxy for European value and growth, we find that the broad MSCI Europe index trades on a 12-month forward P/E ratio of 15.4, the MSCI Europe Growth is at 20.1 and the MSCI Europe Value is at just 10.8 (according to Bloomberg data).
A forecast P/E ratio is a company’s stock price divided by its expected earnings per share over the next 12 months.
Using slightly different data from the Eurostoxx, we see that value stocks in Europe are currently trading at lower PEs than they were five years ago (see below).
The past few years have been brutal for cheap stocks in Europe. There are very few, if any, parts of developed market equities that the market is so bearish about that they have actually fallen over the past five years, either in absolute or relative terms. (A downgrade occurs when a stock’s P/E ratio contracts due to a gloomy or uncertain outlook).
Just to really put the boot in, the US Russell 1000 Value Index is on a 12-month forward P/E of 16.5, while the equivalent in Europe is around 11. This huge differential shows that ‘a cheap stock in the United States is held in much higher esteem than a cheap stock in Europe; Value stocks in Europe are the unloved of the unloved.
The above two points show that there are similar general themes in the United States and Europe, but are more extreme in the latter.
However, the table below is what drives the first two points crazy.
It shows the growth in earnings per share of the Eurostoxx value and growth indices.
Over the past five years, Europe’s cheapest companies have actually delivered After earnings growth than their growth counterparts. This is a typical European phenomenon and not what you see in other developed markets such as the US where you have actually had some earnings growth from growth stocks.
Cynics might say this is due to starting from a low base, as the chart starts in 2017 just as the mining cycle turned positive. But we ran this over multiple time periods and you get the same result.
It should also be noted that the favorable earnings profile for the stock was in place before the Covid-19 pandemic. It’s not all down to the earnings rebound, commodity inflation and interest rate benefits that drove value higher post-pandemic.
So over this five-year period, the real growth stocks in Europe, at least in terms of fundamentals, have been the value stocks.
Value stocks outpaced growth
Put it all together and there’s a compelling reason to believe that value in Europe looks quite attractive; near-slump absolute valuations, record levels of relative valuation discount to growth and positive relative earnings momentum. This is not a widely shared view, however. Indeed, when looking at investor flows and allocations, Europe is one of the most neglected equity markets in the world. Maybe not for long.