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Buying into the future of French companies [ClearOnMoney]
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Buying into the future of French companies

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Investment

Buying into the future of French companies

16 Oct 2012 by Jim Fickett.

A number of European stock markets are undervalued. I wrote about this, basing my analysis on data from a paper by Joachim Klement, earlier (Belgium, France, Germany and the Netherlands have attractive CAPE). There I made the case for buying a French index fund (EWQ), but wasn't quiet comfortable with it at the time. Two recent bits of news changed that.

First, the Global Financial Stability Report that just came out had an overview of investment-grade credits in several countries, and this shows that, for investment-grade companies at least, French balance sheets are in about average shape:

Corporate fundamentals and funding conditions remain strong in advanced economies outside the euro area periphery. Although earnings growth is slowing sharply in all countries amid a generalized economic slowdown, funding conditions and the debt servicing capacity of businesses in most countries remain strong. …

The analysis of corporate fundamentals of investment-grade companies shows a significant divergence between, on the one hand, U.K., U.S., and core euro area firms and, on the other, firms in the euro area periphery (Table 2.4.1). Debt servicing capacity (interest coverage) remains favorable for the former group of countries despite the recent decline in profit growth (as measured by EBITDA) in a slowing economy.

The units in the table are standard deviations. So the ratio of income (as measured by EBITDA) to interest payments on debt is almost 2 standard deviations higher in France than in the other economies listed. On the other hand, the ratio of free cash flow to total debt is almost one standard deviation below average. Overall, French balance sheets are in decent shape.

Second, Pacific Capital Associates just put out a ranked list of the Shiller cyclically-adjusted P/E for a number of countries that helps to put things in perspective (no link). Here is the list up to and including France (ranked by increasing CAPE):

Country CAPE
Greece 2.25
Ireland 4.71
Italy 6.36
Russia 7.21
Portugal 7.77
Austria 7.77
Spain 8.84
Belgium 9.71
Netherlands 10.67
France 11.18

Greece, Ireland, Portugal and Spain are sufficiently likely to experience really deep disruption that I'm not very comfortable with investing there without really understanding how a currency change or government default would affect individual companies, and Belgium is on the edge of that group. The law is a foreign concept in Russia, which for me makes it an unappetizing investment destination. I would guess Austria has such a low P/E because the country has a very large banking sector, and the banks are heavily exposed to the peripheral countries – again not a situation I want to get into.

Unfortunately Italy was not covered in the Klement study, so I don't know how predictive the CAPE is for the Italian market. Netherlands and France remain. I think both are potentially interesting investment destinations.

I will start a position in EWQ. I suspect the European crisis will heat up again and perhaps give a better entry point, so for now I'll invest only 1% of the portfolio.