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Time to Buy European Equities?

28 August 2020 By Mircea Vasiu

2020 has been good so far for the stock market. In most developed markets, it recovered from the March lows in record time. 

The U.S. stock market outperforms its peers. That is not by chance, as studies show that the older the stock market, the higher its returns.

At this point, an investor may be tempted to look at some ratios and decide where their money could be better-placed for the next decade or two. Such a ratio is the one between the U.S. stocks and European equities. It recently reached a hundred-year low, a staggering difference by all means.

Some Valuation Metrics to Consider on Main U.S. Corporations

Let’s talk Apple. This is one of the most innovative companies in the world, and Steve Jobs’ genius changed the way societies work and function. It reached $2 trillion in market capitalization this week, and currently its performance for the year is over 60%. Compounded for the last five years, the annual growth rate exceeds 35%.

However, if we look at revenue growth, it is only up 6% (six!) in 2020, and 4% (four!) if we use the five years compounded annual growth rate. Yet, the company reached its second trillion in market capitalization in record time. More precisely, in less than a year since it reached the first one.

Although one should stop short of saying that the tech sector is a bubble, investing in a company delivering growth rates such as Apple’s should be taken with a grain of salt. At some point in time, maybe not now, investors will want better revenue growth than that. Otherwise, how can an investor justify the stock trading at over 35 times the price/earnings ratio?

People involved in financial markets have a saying that the market may remain irrational more than a trader remains solvent. Indeed, if you look at the performance of Tesla, Facebook, Amazon or Apple, shorts were burned without pity.

For those not aware of the risks when shorting stocks, just consider that the losses are unbounded. However, when buying stocks, one can only lose the amount invested. Hence, brokers will quickly come and ask you for more margin as the stock keeps rising if you are short on that stock. On strong market moves, there is no time to add more funds to the trading account, and the broker triggers the margin call. This is how short squeezes happen, as the broker buys back the shares from the short seller.

Shorting the stock market was never easy. But investors do have an alternative – search for companies offering better valuation metrics.

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