Even as European stock markets face big challenges this year, there are many reasons to invest. Solid earnings growth prospects, attractive valuations and company-specific performance catalysts can help fuel returns. Yet it takes a highly selective approach to get the most out of regional equities.

To some extent, passive equity allocations can capture Europe’s strong earnings potential and discounted valuations. But an active approach is essential, in our view, to identify individual companies with unique business drivers to support sustainable returns.

Strong Earnings Potential

US companies grew their earnings much faster than did European companies in 2018. This trend is forecast to reverse in 2019: Europe ex UK earnings per share are set to grow by 9% versus 8% for the US, according to consensus forecasts (Display, left). Over the longer term, US margins will probably fall from historical highs, most likely as employees finally begin to see their share of company earnings grow relative to shareholders. In Europe by contrast, margins are lower relative to history, meaning there’s more scope for long-term growth.

Attractive Valuations

Valuations contracted sharply almost everywhere in late 2018 and no longer look stretched on most metrics. Yet European equities continue to trade at a discount of around 15%–20% to their US counterparts on a forward earnings basis (Display, right). In part, this discount reflects the different sector composition of the two markets, as the US has proportionally more technology stocks, which are more expensive, while Europe has more industrials and financials, which are cheaper. Still, the discount suggests that returns from European equities should be higher over the long run.

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Company-Specific Catalysts

Company-specific drivers should provide shorter-term catalysts for performance this year, in our view. Many European companies are simplifying their operations or spinning off noncore businesses. In other cases, excessive pessimism about the prospects for some industries, such as autos and auto parts, have driven individual company valuations down to a level from which a rapid rebound is likely—with signs of this already evident in stock markets in January. Private equity and activist investors are becoming increasingly involved in European companies, which signals that smart investors recognize these opportunities and may serve as a catalyst for stronger returns of individual stocks.

Passive investing portfolios are unable to take full advantage of these trends. Our European Equity and Eurozone Equity portfolios take a specialized active approach designed to generate long-term returns in a very complex European market environment. The portfolio team thinks like business owners to find stocks with long-term earnings potential, attractive valuations and company-specific catalysts for performance. That means we target companies that have the potential to deliver results without help from the market—and even if macroeconomic conditions get tougher.

Source: Bloomberg, FactSet, Morgan Stanley, MSCI and AB

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. AllianceBernstein Limited is authorized and regulated by the Financial Conduct Authority in the United Kingdom.

Past performance does not guarantee future results. The value of an investment can go down as well as up and investors may not get back the full amount they invested. Before making an investment, investors should consult their financial advisor.

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