February 9, 2017 / 2:05 PM / a year ago

RPT-Earnings comeback, valuations discount to U.S. fuels case to buy Europe: BAML

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By Kit Rees

LONDON, Feb 9 (Reuters) - After years of underperformance, a long-awaited turn in European earnings and some of the cheapest valuations relative to U.S. in 40 years, could lure investors back into the region’s equities, according to strategists at Bank of America Merrill Lynch.

Sub-par earnings growth, profit margins and return on equity combined with growing political risks have clouded the case for European stocks in recent years keeping investors away.

Meanwhile, U.S. company profit margins are at record highs while earnings have outpaced European peers by 76 percentage points since 2009, according to BAML.

That has powered U.S. equities to record highs this year and on some metrics such as price-to-book now stand at close to a 40-year high relative to Europe, BAML said.

European earnings could be at an inflection point following the brighter outlook for commodity-related stocks and financials, two sectors that have big weights across regional indexes.

Earnings growth in Europe is expected to clock in at 14 percent this year, according to Thomson Reuters I/B/E/S. Profits fell in four of the past five years. reut.rs/2553txN

The latest quarterly reporting season is shaping to be a healthy one. Of the 90 STOXX 600 companies which have reported earnings to date for Q4 2016, more than 53 percent have beaten analyst estimates. In a typical quarter, 49 percent exceed analyst EPS predictions.

So far, the pan-European STOXX 600 index has rallied almost 1 percent in 2017, as the so-called “reflation” trade gathered pace.

The caveat to the optimistic outlook, however, remains European politics.

Elections in the Netherlands, France and Germany and the trigger of Brexit talks in the U.K. could present potential bumps, BAML strategists warn.

Likewise sovereign risks also lurk - Greece’s debt woes are still a cause for concern as is Italy’s banking system.

“Some clarity on these risks seems likely by late 2017 and in fact perceived political risk could turn positive if more reform-minded leadership is in place in some of the major European governments,” BAML’s strategy team said.

“In the short term, however the trajectory for Europe’s performance relative to the U.S. is likely to be somewhat choppy until the political uncertainties clear.” (Editing by Vikram Subhedar)

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