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In sizing up European stocks, look beyond Europe

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John Templeton, one of the greatest investors in history, said his success was the result of buying at the point of maximum pessimism.

Most investors are unable to imitate his example because they lack the stomach to take advantage of such opportunities when they arise. The danger and the volatility are just too great. Which brings us to European equities.

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Europe is a mess. Unemployment is sky high, many countries are in recession, and sketchy policy is making a weak economy even worse. Given the dismal outlook for the continent, I wouldn't touch the region's bank stocks.

But European and British equity markets also include dozens of the world's most dominant companies – companies that generate profits globally, not just in the depressed European Union. They're cheap. And they pay big yields.

Are they risky? Yes, but risk management is another tenet of great value managers. They minimize the use of the word "if" – as in "if the economy recovers, I'll make a fortune on this stock." They prefer to deal with hard numbers.

Benjamin Graham, the father of value investing, wouldn't buy a stock unless he was sure he could make a profit by selling the underlying equipment even if the firm went bankrupt. Warren Buffett has updated the technique and avoids any company without a history of at least 10 years of near bulletproof, volatility-free earnings and cash flow growth.

So in searching through the wreckage of European equity markets, investors should look for stocks that are not only cheap, with sizable yields, but also protected in some way. European telecoms, for instance, have the implied support of national governments. The energy companies are to varying extents shielded from regional economic weakness by foreign revenues.

The accompanying chart shows the price-to-earnings ratios and dividend yields for European stocks that might be worth some attention for investors. The chart also includes the percentage of analysts who rank the stock as a buy.

This is only a starting point for your research, of course. There are problems with each of these companies – otherwise they wouldn't be trading with such large yields. Some of them will cut their dividends, but for investors that uncover the stocks that won't cut, the next three years should see substantial returns.

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More risk-averse investors looking to play this theme can choose among a host of exchange traded fund options. Vanguard has the U.S.-traded Vanguard FTSE Europe ETF and there is also the First Trust STOXX European Select Dividend Index Fund. (although in the latter case I wouldn't expect the indicated yield to be sustainable).

Investing in European dividend stocks is not a strategy for everyone: It takes guts and the willingness to do your homework. But the potential returns are significant and if investors are wondering where the world's greatest investors are looking for value, they are already there.

"Europe's economic problems present a buying opportunity," Mr. Buffett says. "We've been buying some European stocks and companies in the past year."

Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights , and follow Scott on Twitter at @SBarlow_ROB .

The Globe has launched a Streetwise and ROB Insight newsletter, with content available exclusively to Globe Unlimited subscribers. Get the best of our exclusive insight and analysis delivered straight to your inbox in a daily e-mail curated by our editors. Sign up for it and other newsletters on our newsletters and alerts page .

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About the Author
Market Strategist

Scott Barlow is The Globe's in-house market strategist. He is a 20-year veteran of Canadian investment banks, including Merrill Lynch Canada, CIBC Wood Gundy and Macquarie Private Wealth (MPW). He was a highly ranked mutual fund analyst for 10 years and then, most recently, the head of a financial adviser support team at MPW. More

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