- In terms of fundamentals, the German stock index is overvalued compared to the S&P 500.
- However, there are a few stocks that could offer interesting diversification possibilities as revenues aren’t that dependent on Europe.
- Some companies also give inflationary protection which is one of the greatest European risks for investors in the long term.
I’ve described the investment environment in Europe as very risky due to the many black swans that could hit it, from political to financial issues. Nevertheless, this doesn’t mean that there aren’t any good investments in Europe, especially for those who want to take advantage of the liquidity provided by the ECB and from the possibility that the ECB follows the Bank of Japan, i.e. starts buying stocks when it becomes clear that buying corporate bonds isn’t enough to keep the economy growing and to spur inflation.
In today’s article, I’ll analyze the lowest risk of the European economies, Germany, and its stock Index, the DAX. From a performance perspective, the DAX has significantly underperformed the S&P 500 in the last 10 years.
Figure 1: The DAX is up just 50% from 2007. Source: Yahoo Finance.
Additionally, the recent strengthening of the Euro might continue and may be a benefit to international investors. It’s also important to always compare valuations across countries in order to see if similar global companies have different valuations.
German DAX Valuations
The best way to see if an index is worth investing in is to analyze its constituents on an individual basis.
Figure 2: The DAX index on an individual company basis. Source: Author’s data.
The average price earnings (P/E) ratio of 23 is a bit better that the 24.6 of the S&P 500, but the CAPE (cyclically adjusted P/E ratio which takes into account 10 year average earnings) is at 42 and thus much higher than the S&P 500’s CAPE of 30. The difference in the dividend also isn’t significant as the DAX offers 2.4% while the S&P 500 offers 1.9%.
With all the risk and the negative fundamentals that Europe carries, from negative demographics and anemic economic growth, the DAX index on aggregate looks expensive compared to the S&P 500. Let’s see if there is something interesting with individual sectors or stocks.
Individual German Stocks
Adidas AG has a P/E ratio of 35 which is much higher than Nike’s (NYSE: NKE) 23.81. In the table above, I’ve highlighted the companies that have low P/E and CAPE ratios. Not surprisingly, the cheap sectors aren’t that different than the cheap sectors in the U.S. with automotive producers, insurance companies, and airlines being extremely cheap.
German car manufacturers might be a good diversification option for those who like the industry. The German big 3—Daimler, BMW, and Volkswagen—have globally diversified revenues while they have the advantage of extremely low interest rates in Europe.
Figure 3: Daimler’s sales growth in China. Source: Daimler.
Therefore, when looking at automotive manufacturers, don’t shun European producers just because they are in Europe. They are global players and have cheap valuations.
Another interesting option from Germany is BASF AG, the largest global chemical producer, which offers a dividend yield of 3.7%. This is another investment isn’t that related to Europe with a relatively high dividend yield.
Figure 4: BASF has globally diversified sales. Source: BASF.
The largest German airline, Lufthansa, has a really low P/E ratio as it has been battered in the past by strikes, European terrorist threats, and competitive low-cost airlines. Nevertheless, the Lufthansa Group has its own low cost carrier, Eurowings, which is growing at 4.5% organically while the company is still priced at a very low valuation. Given that U.S. airlines aren’t that cheap anymore since Buffett bought them back in 2016, it might be a good idea to look at Lufthansa to diversify.
Figure 5: Lufthansa’s revenues have seen positive movements all around the globe. Source: Lufthansa.
For those looking at European real estate investments, Vonovia SE might be an interesting opportunity. Vonovia is Germany’s leading real estate company and owns 355,000 apartments across Germany. Given that it owns real estate and its debt maturity profile is well spread over the next decade with an average maturity of 6.7 years, the company should benefit from possible inflation in Germany. Higher inflation would allow it to increase rents while it would take a much longer time for the company to be affected by higher interest rates. Thus Vonovia offers protection from one of the greatest European risks, inflationary pressure coming from the ECB’s constant money printing. The dividend yield is 3.1% while the fund from operations yield is 5.29%.
Figure 6: Vonovia’s real estate portfolio. Source: Vonovia.
By looking at the aggregate German market, it’s easy to conclude that it is overvalued for the risks inherent to the European economy. Germany is solid as a rock, but it can’t avoid the potential spillovers coming from imminent future defaults of southern European states, especially if inflation and interest rates increase.
Nevertheless, global companies like Daimler, BASF, BMW, Volkswagen, and Lufthansa look relatively cheap when compared to their global peers, especially as European companies have the benefit of borrowing at negative interest rates thanks to the ECB buying their bonds.
If you are interested in investing in Germany, I hope to have shown that there are some relatively cheap investments there and that it is much better to invest in specific companies after some proper due diligence than to buy and ETF or an index fund.
I know it takes more effort to buy European companies, but all of the companies mentioned above are also traded in the U.S. as ADRs on the OTCPK market. As for the due diligence, I hope I have pointed you in the right direction with this analysis.