Where there is chaos there is money to be made: Inside the Euro Zone. The key to making money – or avoiding losses – in the Euro Zone today may come from tracking the gap between analysts’ perceptions and stock market reality.

Released: June 20, 2012
Length: 3 Minutes

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Buy Ireland? Sell Greece? Beware of Portugal. Watch the 3 minute video to see how StarMine analytics can provide buying, holding, or selling insights for the Euro Zone—with a 70% accuracy rating.

Market mayhem may not be terribly enjoyable – but it can be very, very profitable, as a New Yorker cartoon a few decades ago pointed out. It may be hard sometimes to remember this while feeling the urge to react in a knee-jerk fashion to every headline dealing with Greece’s political gyrations or the dire plight of the Spanish banking system. But the disconnect between analysts’ perceptions and stock market reality may still offer up some opportunities to calm and thoughtful investors – even if it is just the opportunity to steer clear of potential trouble spots.

Currently, analysts worldwide have a Buy or Strong Buy rating on 57% of the stocks they follow for investors, according to data compiled by StarMine. They recommend selling only 9% of the stocks they track, while maintaining a Hold rating on 34%. The greatest number of Holds is in North America; analysts covering North American companies appear more ambivalent and reluctant to commit themselves to either a Buy or a Sell rating. In the eurozone, interestingly, analysts have a Buy or Strong Buy recommendation on 51% of the 1,600 stocks domiciled in the region that are tracked by StarMine. But the eurozone also accounts for a higher proportion of Sell ratings – there’s much less ambivalence here on the part of analysts!

Table 1.  Percent of recommendations by category, as of June 13, 2012.

Digging further into the European data displays some intriguing results. Ireland, one of the earliest eurozone members to hit trouble and require bailing out, now is struggling to return to economic health. Currently, analysts have Buys or Strong Buys on 59% of Irish companies that they cover. Ireland also has the second-lowest level of Sells and Strong Sells – 13%. In a deeply ironic twist, the ratio of Sells is identical with that of Germany (perhaps it’s not surprising that the rate of Sells is so low there, given that country’s status as the strong man of Europe) and also, more oddly, with Greece. In contrast, analysts have delivered a “thumbs down” rating to 25% of all Spanish stocks, while 19% of those in Portugal have been hit with a Sell or Strong Sell rating.

But it’s important to set those perceptions on the part of analysts in the context of market reality, in the form of the earnings growth calculations for companies, calculated by StarMine in the form of compound earnings per share growth for the next five years. Similarly, it’s important to measure the market’s expectations against what analysts forecast.
Right now, analysts are saying one thing but financial markets are painting a different picture. Worldwide, analysts are calling for corporate earnings to grow at a forward five-year annual compound growth rate of 8.4%. In practice, however, markets are underpricing that growth dramatically; based on current valuations, the market implied growth rate is actually negative. That means investors today believe that markets will contract by about half a percent over that period. So there is a spread of nearly nine percentage points between what analysts believe will happen and what investors, reflected in market valuations, expect to happen – a tremendous difference.

If we re-rank the various regions of the world by looking at this spread – the difference between analysts’ expectations and the market-implied growth rate – we see a new picture emerge. North America has the tightest perception-reality spread of only 5.7 percentage points; analysts and the market seem to agree generally on the kind of growth they expect to see from companies in the coming years. Next comes Ireland.

Table 2.  Analyst forward 5-year EPS compound annual growth rates, as compared to the same growth rates implied by recent market pricing, as of June 13, 2012.  The Difference column rank is from lowest to highest.

At the bottom of that list? Not surprisingly, that is where you can find Greece: analysts and the markets can’t seem to agree on what kind of growth pattern will take shape and what to expect from the country’s stock markets. Following closely on Greece’s heels are Spain and Italy.
Intriguingly, however, Portugal is one of the countries with the narrowest spreads – even narrower, in fact, than that measure for Germany, the strongest eurozone economy and the one likely to end up footing much of the bailout bill for the weaker members on the periphery of the Eurozone, Portugal among them. Given the fact that the data from analysts with respect to their views of Portuguese stocks is so downbeat, with analysts recommending not touching 19% of companies in the country, this gap starts to resemble other periods of time when reality temporarily parts company with market valuations. Most market participants may remember the dot.com era of the late 1990s – a period memorably described by the former Federal Reserve Chairman Alan Greenspan as one of “irrational exuberance”. Of late, some high-expectations stocks have similarly big gaps between their market valuations and investor outlooks; Amazon (AMZN.O), as we have discussed previously on AlphaNow, is one of those whose stock price today looks out of step with its prospects. The odds are that the spread between analysts’ expectations and market-implied growth will widen more with respect to Portugal – unless the analysts who track Portuguese equities begin to boost their ratings on those companies.