Things Are Looking More Positive in Europe | American Funds

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Global Growth | International | April 2015

Things Are Looking More Positive in Europe

Continued improvement in sentiment could produce meaningful sales growth for many companies. Oil price weakness and dollar strength only help the situation.

“I think there is a compelling case to be made for investing in Europe. If Greece and Ukraine become a bit more stable, the valuation gap will narrow.”

Andrew B. Suzman Portfolio Manager New York office 23 years of experience (as of 12/31/16)

Potential operating leverage opportunities in Europe

Image lists European companies that continue to trade at a discount to U.S. peers.

Sources: Thomson Reuters Datastream, FactSet, Bloomberg. As of February 28, 2015.

Europe is showing signs of improvement, despite unaddressed structural issues. But many companies domiciled in the region continue to trade at a discount to U.S. peers due to lower operating margins (EBIT). Margins remain low because of some high fixed costs, including labor, and anemic revenue growth emanating from the region. But larger fixed costs mean that operating leverage tends to be higher in Europe than in other regions.

EBIT margins of the STOXX Europe 600 Index have yet to surpass prior period peaks, while the EBIT margins of the S&P 500 continue to expand, reaching new highs in 2014. The difference in EBIT margins between the two indexes is near its widest level in the last 10 years. There is also a disparity between the valuation of S&P 500 companies and those in the STOXX Europe 600 Index.

Operating leverage can be powerful when an economic environment is improving and can result in rapid earnings estimate revisions as well as multiple expansion. The European Central Bank’s quantitative easing program, a pickup in business activity in  the euro zone, or any positive news out of Greece or the Ukraine could produce meaningful sales growth for many companies that have large business exposure within the EU. As potential European sales growth occurs, investors could quickly close the valuation gap between European and U.S.-domiciled companies.

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Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and not to be comprehensive or to provide advice.