According to a new report from Morgan Stanley Research Europe published on June 9th, European large cap stocks have put a poor first quarter behind then and are set for multiple quarters of EPS expansion.

European large cap stocks EPS growth

Morgan Stanley analysts Matthew Garman, Krupa Patel and Hanyi Lim summarize their bullish perspective in the overview of the report. “Our margin lead indicator continues to point to margin expansion this year and this could surprise analysts positively. We nudge down our 2014 EPS growth from 10% to 8% to reflect 1Q weakness, however leave 2015 growth unchanged at 12.”

Nearly all indicators pointing to impending European large cap stocks’s EPS growth

European large cap stocks EPS

According to the Morgan Stanley report, nearly all of their proprietary indicators are pointing to EPS growth in European large caps relatively soon. For example, the European Growth Lead Indicator (EGLI) suggests a healthy 14% EPS growth over the next year, and the latest reading from MS’ Margin Lead Indicator (MLI) points to at least 60 bps of margin expansion over the next four quarters.

However, Garman et al also note that they do not expect significant expansion in P/E ratios over the next few quarters despite the high likelihood of solid increases in EPS.

FX negatively impacting Q1 EPS

European large cap stocks EPS fx drag

The analysts say they decided to slightly reduce their 2014 European large cap EPS growth forecast from 10% to 8% to reflect the weakness seen in 1Q. However , they emphasize that the downgrade should be seen only “as a marking-to-market exercise” and that they “remain confident that we are about to see a turn in the earnings newsflow as we move into 2H. We believe the strength of the Euro has been a significant drag on revenues and profits over the last quarter or two. However, as illustrated in Exhibit 8, we believe this effect will start to fade going forward. We continue to forecast 2015 EPS growth of 12%.”

Minimal downside risk vs consensus estimates

Finally, the MS analysts point out that their revised estimate of 8% for 2014 EPS growth is “still above bottom-up consensus expectations of 7% and supports the view we have articulated over the last couple of months that now is the wrong time to turn more bearish on European earnings.” Garman et al “remain confident that European EPS troughed in 1Q and should start to rebound through the remainder of this year.”

European large cap stocks EPS consensus margin

The MS analysts also point out that consensus margin expectations “continue to drift down despite the message from our margin lead indicator”, which they argue is likely to lead an upside surprise over the next few quarters.