Look for opportunity amid Europe's woes

Europe's debt crisis has shaken US markets recently, but it could have bullish results.

By John Reese May 14, 2010 3:39PM

Greece's debt woes and their spillover into other parts of Europe have been bad news for the euro, with the currency plummeting toward levels it hasn't seen in four years. And the pain is spilling over into the U.S. markets, hitting the major indices hard. 

 

But once the initial fears subside, will Europe's troubles, and the euro's accompanying plunge, be bad news for stock investors going forward? Not necessarily. For one thing, the recent crisis has hammered European stocks -- including those of many solid, stable companies that are now selling at bargain prices.

For another, the euro's decline may actually help European companies that have substantial global operations, or that are major exporters. 


As David Herro -- one of Morningstar's Fund Managers of the Decade -- explained in a recent interview, a drop in the euro will make such companies more price-competitive overseas. And, he says, those companies will also benefit by making big chunks of their profits in stronger currencies. Herro says he's been keying on some European shares that he thinks have been unfairly beaten down recently. 


Herro is not the only top manager who's seeing opportunities in Europe. 


Hedge fund guru Barton Biggs recently told Bloomberg that Europe is actually in the midst of a strong economic recovery, the Greece crisis notwithstanding. And he says a significant drop in the euro could be very bullish for European stocks, for reasons similar to those Herro cited. 

 

My investment philosophy is based on the idea that individual investors can learn a lot from history's greatest market minds. That's why I created my Guru Strategy computer models (each of which is based on the approach of a different investing great), and it's why I take notice when proven performers like Herro and Biggs speak. Their recent comments got me wondering which European stocks trading on U.S. exchanges -- particularly those that do a lot of businesses outside of Europe -- are getting interest from my guru-based models.

 

I found that my models are indeed finding a number of bargains among such stocks. These types of contrarian picks aren't for the faint of heart, however, and it's important to remember that unforeseen developments in the debt crisis could have significant impacts on European stocks, particularly in the short term. But if you have the stomach, here are a couple of companies my models suggest are worth a long, hard look.

 

Novartis AG ADR (NVS): This Switzerland-based pharma company makes a variety of brand-name and generic medications, and is also a major provider of vaccines, diagnostic tools, and products for human and animal health care. The $110 billion market-cap company operates in 140 countries, and gets approval from both my Peter Lynch-inspired approach and my James O'Shaughnessy-based value model.

 

My Lynch model considers Novartis a "stalwart" because of its high sales ($47.5 billion over the past year) and moderate 10.5% long-term earnings per share growth rate, (I use an average of the three-, four-, and five-year EPS growth rates to determine a long-term rate). Lynch found that these type of large, steady firms offered protection during downturns.

 

To find growth stocks selling on the cheap, Lynch famously used the P/E/growth ratio, which divides a stock's price/earnings ratio by its long-term growth rate, adjusting the "growth" portion of the equation to include dividend yield for stalwarts. Novartis' yield-adjusted P/E/G is 0.81, which comes in under my model's 1.0 upper limit -- a sign that it's a bargain.

 

My O'Shaughnessy-based value model, meanwhile, looks for large companies with strong cash flows and high dividend yields. Novartis' size, $5.22 in cash flow per share (vs. the market mean of $0.88), and 4.0% yield all make the grade. 

 

Alcon (ACL): This 65-year-old company offers surgical products, pharmaceuticals and consumer products designed to help with eye problems. While majority-owned by Nestle and incorporated in Switzerland, the $46-billion-market-cap firm operates in more than 75 countries and has a U.S. base in Texas.

 

Alcon gets strong interest from my Warren Buffett-based Guru Strategy. This approach looks for companies with lengthy histories of earnings growth, manageable debt and high returns on equity (which is a sign of the "durable competitive advantage" Buffett is known to seek). Alcon delivers on all fronts. Its EPS have dipped in only two years of the past decade, and the dips were pretty minor; it has no long-term debt; and its 10-year average ROE is an exceptional 38.2%.

 

Disclosure: I'm long NVS and ACL.


John Reese is founder and CEO of Validea.com, a premium investment research site, and Validea Capital Management, a separate account advisory firm. He is author of the new investing book, "The Guru Investor: How to Beat the Market Using History's Best Investment Strategies".


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