The Time to Buy German Stocks is NOW

David Sterman's picture

Wednesday, June 27, 2012 - 1:00pm

by David Sterman

First it was Greece, then it was Italy, then it was Spain... and now Cyprus? The list of weak European economies that might need a bailout keeps growing, and bold action will continue to be required. But headlines like these are overshadowing some compelling values that are beginning to emerge in Europe. 

Sure, you run the risk of seeing any European investment drop further in value in coming weeks, but some stocks and funds are entering into the deep value zone. And with a longer time horizon in mind, smart investors could see solid gains.

Seeking bargains often means looking for value among weaker stocks and funds, many of which toil in structurally disadvantaged economies. Yet the current European sell-off has also dragged down stocks and funds of a top economic performer -- Germany -- which remains as a global powerhouse even as its neighbors stumble badly. And although European economic troubles will likely keep a lid on German economic growth in 2012 and 2013, the country's top companies are still poised to flourish for many years to come.

Consider car maker Daimler (Pink Sheets: DDAIF). Best known for its Mercedes brand of automobiles, the company has seen its market value fall by one-third in just the second quarter of 2012. Compared to one year ago, this company's market value has fallen by nearly half, from $80 billion to $44 billion. The fact that Mercedes remains a coveted brand in stronger economies such as China, the United States and elsewhere is seemingly irrelevant to the stock price right now. Analysts concede that European economic troubles will cause Daimler's sales to be flat this year, at around $106 billion, but they see sales rising 15% to 20% next year as depressed markets snap back.

Or consider the fate of Germany's Siemens (NYSE: SI), which has seen its market value drop to a recent $70 billion from $120 billion a year ago. The "GE of Europe" has strong market share in dozens of countries across the globe, and long-term contracts insulate it from sudden economic slowdowns. 

Even during the slowdown of 2008 and 2009, Siemens never generated less than $2 billion in free cash flow. The forward view for Siemens -- once the economic rough patch passes -- looks quite bright. Management has steadily shifted the company's sales focus into niches that carry the most robust margins. EBITDA margins, which have historically been in the 8% to 12% range, hit a record 14.4% in fiscal (September) 2011.

The smartest way to play
Coming out of the current economic slowdown, it might be hard to predict which German companies and industries will post the strongest rebound. Will chemical maker BASF (Pink Sheets: BASFY) flourish?  What about software giant SAP (Nasdaq: SAP)? It's hard to know for sure. That's why I prefer to invest in the iShares MSCI Germany Index ETF (NYSE: EWZ). It holds stakes in the top German companies, all of which have a global export focus.

Yet as the fears of a European economic meltdown have risen, investors have been abandoning this fund. It's fallen so sharply in the second quarter of 2012 that the aggregate price-to-book ratio for all of the fund's holdings has dropped to just 1.1. It's a rare moment indeed when you can buy Germany's leading blue chip stocks for just above book value.

Now's the time to buy
It's unclear how the European crisis will play out, and the possibility looms that at least one country will have to leave the euro. For now the crisis has led to a sharp sell-off in that currency, especially against the dollar and the yen. As a result, many of these German exporters are gaining a tangible boost, both in terms of their pricing competitiveness in foreign markets, and in the increase in profits when they are repatriated back into euros.

Risks to Consider: If the weakest countries in Europe leave the common currency, then the euro would eventually strengthen, as it will be more closely tied to the region's strongest economies. A stronger euro may blunt the competitiveness of some German firms in export markets.

Action to Take --> These German stocks can surely fall further in value. But current valuations imply that these investments will be marked up to fresh highs when the global economy is back on firmer footing. As I mentioned earlier, the Germany index fund is the best way to blunt the downside while also giving you a chance for ample upside.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.