We have been arguing for quite some time (although we are not a registered investment advisor nor offering investment advice, see our legal disclaimer for more details) that Europe (especially the periphery) offers value for those with the stomach for volatility. We have specifically pointed to Greece although we noted many of the ‘Northern European’ countries are also cheap. Morgan Stanley is out with a report on the cheapest stocks in Europe. They specifically use two famous value formulas for European equities; Ben Graham stocks, and Joel Greenblatt’s Magic Formula. Morgan Stanley has 8 criteria but we focus on 1 and 4 and those which match the criteria of several screens.
1) Joel Greenblatt – Screen for stocks with high ROCE and low EV/EBITDA.
2) Private Equity – A strategy that seeks to identify undervalued stocks based on metrics commonly used by private equity investors.
3) Surplus Cash Yield – Defined as surplus cash yield as a stock’s FCF yield minus its dividend yield.
4) Ben Graham Stocks – Inspired by Ben Graham’s ‘Intelligent Investor’ MS screens for stocks with adequate size, healthy financials, EPS & DPS stability, good EPS growth and moderate valuations.
5) 3 U’s – Screen for stocks that are unloved, undervalued and under-owned.
6) EV/Fixed Assets – The most basic valuation metric in our Private Equity screen.
7) DY > PE – Screen for stocks where the dividend yield is above the PE ratio.
8) N12M relative valuation lows versus history – Screen for stocks whose N12M PE, PBV and DY ratios are low elative to history (25th percentile or less).
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Below we examine stocks which make the two lists.
Ben Graham stocks – Europe
Morgan Stanley first launched their Ben Graham stocks inspired screen in their report ‘The Intelligent Investor, Chapter 14, 6 March 2006’ and have written about it regularly since. The aim of this strategy is to buy companies with the following criteria:
- Adequate size (market cap > $500m and sales above $100m);
- Healthy financials (current ratio > 2 and LT debt < working capital);
- EPS and DPS stability (both EPS and DPS above 0 in each of last 10 years);
- Earnings growth in last 10 years > 33%;
- Moderate valuations (PE < 15 and P/B < 1.5 and PE*P/B < 22.5).
Morgan first launched their Joel Greenblatt inspired screen in a report titled ‘Beyond Beta, 1 August 2006’ and have written about it regularly since. The screen is based on the premise of buying quality companies ‘on the cheap’. The screen ranks non-financial companies on two criteria, 1) ROCE (high is good) and 2) EV/EBITDA (low is good).
Finally, Morgan Stanley has a screen on stocks which match several value criteria.
In the chart below Morgan Stanley show those stocks which appear in 3 or more of the 8 screens.
Stocks shaded grey are rated Overweight by Morgan Stanley analysts.
Stocks that are in Morgan’s European model portfolio are:
Royal Dutch Shell Plc (NYSE:RDS.A) (NYSE:RDS.B) RWE AG (ETR:RWE), Bayerische Motoren Werke AG (FRA:BMW) (BIT:BMW), Eni SpA (NYSE:E) (BIT:ENI), AP Moeller – Maersk A/S (CPH:MAERSK-B) (CPH:MAERSK-A), Gas Natural Inc (NYSEMKT:EGAS) Rio Tinto plc (NYSE:RIO) (LON:RIO). Note that investors must do their own work but there are many names here which are not cigar buts but large companies with strong brands (possibly notes). These charts could be a good place to start hunting for value.
Further reading Ben Graham Formula and Malaysian Value Stocks