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Foreign Stocks & Emerging Markets

4 European Stocks to Buy Now

The economic news from the Continent is dreary. But some multinationals look compelling.

Choosing European stocks over U.S. stocks the past few years has meant living in constant hope—and suffering constant disappointment. Americans were much better off staying home.

Since the end of 2010, Standard & Poor’s 500-stock index has returned 73%, far exceeding the 38% gain of the MSCI Europe index. Making things worse for U.S. investors, the euro has declined against the dollar, further sapping the MSCI Europe’s return.

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But the disparity in performance just boosts Europe’s allure for some value-hunting investors, who say the region’s stocks are relative bargains in a world of pricey assets. “Europe is filled with great companies,” says Dean Tenerelli, the London-based manager of T. Rowe Price European Stock, a $1.8 billion fund that holds stakes in big companies such as food titan Nestlé (NSRGY) and drug maker Novartis (NVS). He concedes, though, that it’s tough for many investors to get past the gloomy headlines.

Start with the economy. After reviving modestly in 2013, Europe is again struggling amid government austerity measures, a still-hobbled banking system and the threat of economic fallout from the conflict between Russia and Ukraine. In the second quarter, the 18 nations that share the euro currency showed no growth, on average, from the first quarter. The European economy has been so anemic that it runs the risk of a Japanese-style deflation, meaning a debilitating spiral of falling prices and wages. 

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More help. The economy’s troubles have put renewed pressure on the European Central Bank to provide additional monetary stimulus. The ECB launched new programs in September to try to funnel more money into the euro zone economies, and ECB president Mario Draghi has hinted that the bank could go further. “The expectation out there is that the ECB can do something more,” says Don Rissmiller, chief economist at Strategas Research Partners, an investment firm in New York City. “But this time, it has to work.”

More financial stimulus from the ECB could, however, further devalue the euro, which would hurt U.S. investors. The euro has lost 5.8% against the dollar this year, to a recent $1.30. The drop makes sense given the weakness of Europe’s economies. A sliding euro could help European-based multinational firms better compete with U.S. rivals, because prices of European goods and services get cheaper in dollars as the euro falls.

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But the declining euro also hurts U.S. investors holding European stocks, because the value of the securities drops when they’re translated from euros to dollars. So far this year, for example, Germany’s main stock index, the DAX, gained 2% in euros but was down 4% in dollars (all prices and returns are through September 5).

So with all that, why bother looking across the Atlantic? “We see big discrepancies in share prices versus companies’ intrinsic value,” says Rob Taylor, comanager of Oakmark Global fund. The fund, which can invest worldwide, hunts for stocks that Oakmark believes should rise at least 30% to reflect the underlying company’s true value. Taylor and his analysts have found enough candidates in Europe that the fund at midyear had more than one-third of its $3.7 billion in assets in shares of companies in developed European countries (including the United Kingdom). That was a bit more than the average global fund’s 31% stake in European stocks, according to Morningstar.

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Oakmark Global’s second-largest holding is Credit Suisse Group (CS). Although many investors still shun banks in the aftermath of the 2008 crash, Taylor thinks Credit Suisse’s rebuilt capital base and focus on private and investment banking will translate into healthy long-term profit growth. And with CS’s American depositary shares trading at $28, “you’re paying less than 10 times estimated 2015 earnings for the business.” (Many foreign stocks trade in the U.S. as ADSs or as the similar American depositary receipts.)

For investors who prefer a name they know, Nestlé (NSRGY) is a classic growth story that’s worth a look. The Swiss company is the world’s largest food processor, with brands including Lean Cuisine, Gerber and Alpo. It’s expected to earn $3.90 per ADR this year, rising 12%, to $4.35, in 2015, says Andrew Wood, an analyst at AllianceBernstein in London. He recommends the stock in part based on Nestlé’s huge presence in the developing world, which already accounts for 45% of sales. Growth in emerging nations has helped Nestlé’s stock, now $77, more than quadruple over the past 10 years.

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For income-seeking investors, many European stocks offer rich dividend yields—in many cases north of 3%, compared with an average of 2% for S&P 500 stocks. Dividend generosity “says that management has discipline about the company’s capital and an awareness of shareholders,” says T. Rowe Price’s Tenerelli. His second-biggest holding is the British–Dutch energy giant Royal Dutch Shell (RDS.B), whose Class B shares, at $84, yield 4.5%. Shares of two big U.S. rivals, ExxonMobil and Chevron, yield 2.8% and 3.4%, respectively.

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(One caution on foreign dividends: Some countries withhold taxes on dividends paid to foreigners. The IRS allows you to claim a credit on foreign taxes paid, but that’s no help if you own foreign stocks in tax-deferred accounts, such as an IRA. Check with your tax adviser before buying any foreign security for income.)

Royal Dutch is a favorite big-energy-company pick of brokerage Barclays Capital. With rising production from its wells in the Gulf of Mexico and a new focus on controlling costs, the oil-and-gas company can currently cover both capital-spending requirements and dividend payments solely from the cash that the business generates, Barclays says. That leaves “significant room” to further reward shareholders via dividend hikes and share buybacks, Barclays says.

The potential for steady dividend increases figures prominently in the appeal of London-based Rio Tinto (RIO), one of the world’s biggest mining firms, particularly for iron ore. The company has slashed costs as demand for many commodities weakened over the past year. The result was a surprising 21% jump in profits from its core businesses in the first half of this year. At $53, Rio Tinto’s ADRs yield 3.8%, and analysts at brokerage Canaccord Genuity in London say the company has the wherewithal to hike its payouts substantially. Rio “is now moving toward the happy position of having surplus cash,” Canaccord says. And if commodity prices pick up, that would be gravy for Rio—and its shareholders.

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