As investors, we should never let a good crisis go to waste. “The time to buy,” Baron Rothschild recounted long ago, “is when there is blood in the streets ... even if it is your own."
I opened the June 2010 issue of the Sizemore Investment Letter with this same quote. As much as I hate to recycle good one-liners, I do it today for a reason. You see, in late spring of this year the European sovereign debt crisis rippled through the world economy, creating great buying opportunities in companies like Telefonica (TEF), the Spanish-based global telecommunications firm. After months of relative quiet - in which Telefónica and other solid European blue chips had a great run - we’re right back where we started. The global economy is being shaken again by European sovereign debt woes, this time centered on Ireland. To quote Yogi Berra, “It’s déjà vu all over again.”
So, as the markets sold off in anticipation of the Irish bailout, I decided to go investment fishing in the eye of the storm - Ireland herself.
Figure 1: The Irish ISEQ Overall Stock Index
Few stock markets have taken as much abuse in recent years as the former “Celtic Tiger.” The Irish stock index fell a full 80% from peak to trough (see Figure 1).
Yet remarkably, Irish stocks never got particularly cheap. Irish stocks have the highest P/E ratios and lowest dividend yields of all European countries on Figure 2. Some of this is a “denominator effect,” of course. Earnings fell even faster than price, causing the Price/Earnings ratio to remain high even as stocks sold off. This was particularly true of the Irish banking sector, which has losses big enough to skew the valuation of the entire Irish stock market. Still, Irish stocks as a whole are simply not cheap enough for me to be interested.
Figure 2: Select European Markets
But perhaps there are individual bargains to be found? Well, so I thought. Alas, Ireland is a small market and the pickings of Irish stocks that trade as ADRs in the United States are rather slim. Ireland’s best blue-chip companies - such as building materials producer CRH (CRH), food producer Kerry Group (OTC:KRYAY) and discount airline Ryanair (RYAAY) - get most of their revenues from outside of Ireland and have not sold off during the panic. Their share prices have remained remarkably resilient, and none trade at a particularly attractive price.
The only American-traded Irish stocks that have sold off are the banks - and I wouldn’t touch them with a 10-foot pole right now given the uncertainty facing them.
For most Irish companies actually worth owning, you’re just not going to get that “blood in the streets” price that I was hoping for.
The Pain in Spain
In the November issue of the Sizemore Investment Letter I wrote, “Given the extreme bullish sentiment towards Asia and Latin America and the lukewarm sentiment towards America and Europe, I think it is highly likely that U.S. and European stocks are the surprise outperformers over the next year.”
While Irish stocks as a whole are not as cheap as I would like given the macro risk to the country, I am definitely seeing value elsewhere in Europe. Returning to the P/E ratio table I showed earlier, the only country with “blood in the streets” pricing is Spain. Part of this is legitimate worry that Spain is simply too big to bail out like Greece or Ireland and that the country is at high risk of defaulting on its debts. While I don’t see Spain defaulting, if it were to happen all Spanish stocks would at least temporarily plunge in value, even rock-solid multinationals like Telefonica.
The question becomes, “at current prices, are we being compensated for this risk?” And to this I give an emphatic “yes!”
Telefonica (TEF) is trading at a P/E ratio of 7. Yes, 7. This is one of the finest telecommunications companies in the world, with a leading position in some of the fastest-growing emerging markets in the world ... and it has been effectively left for dead. At current prices, Telefónica would seem to be a “risk free” investment in the old Graham and Dodd criteria. Your risk of long-term or permanent impairment of capital would be almost nil.
The risk with Telefónica today is that it goes from ridiculously cheap to even more ridiculously cheap due to a spate of volatility in the Spanish market. This is a risk that I am willing to take.
I want to strongly reiterate my “buy” recommendation in Telefonica. If you haven’t bought shares yet, this is a second opportunity. And if you already have, then this is a great opportunity to accumulate more shares.