NEW YORK (Reuters) - Europe, long a scapegoat for weak earnings at U.S. multinational companies, is now looking like a more dependable source of profits, and that could make some stocks that have lagged this year’s rally more enticing to investors.
Big players in the technology sector, which has the highest exposure to Europe, are among those best positioned for a boost to the bottom line from the region’s gradual recovery.
On a price-to-earnings basis, tech as a group is nearly 8 percent cheaper than the benchmark S&P 500 index, now at its most expensive since late 2008, suggesting some tech stocks may have room to catch up.
Tech names with some of the highest exposure to Europe, based on Bank of America Merrill Lynch data, have mostly underperformed this year. IBM (IBM.N) is down 8.5 percent on the year, while Oracle (ORCL.N), is up just 3.7 percent. Both derive at least 32 percent of their sales from Europe. Meanwhile the S&P 500 .SPX is up 25 percent.
Energy, which also has high exposure to Europe, lags the S&P 500’s gains as well.
The euro zone, a source of weak sales for S&P 500 companies for several quarters, emerged from its recession earlier this year. If its recovery persists, the region could help U.S. earnings get off their own path of lackluster growth.
“It’s important for investors to realize Europe doesn’t have to be a hole anymore in earnings,” said Joseph Quinlan, managing director and chief market strategist at U.S. Trust, Bank of America Private Wealth Management in New York. “Even a little growth in Europe is going to go a long way to help boost the profitability of U.S. multinationals.”
To be sure, a rebound in Europe is expected to be slow and spotty, much like the U.S. recovery, and many argue optimism about the improvement is premature.
While the European Commission has forecast 1.1 percent GDP growth in 2014 after a 0.4 percent contraction this year, the European Central Bank last month surprised investors by cutting interest rates to help spur its tepid growth.
Relative enterprise valuation data on companies with the most foreign exposure are trading close to their steepest discount to more domestically oriented names in the last decade, BAML data showed, while its global fund manager survey showed managers are overweight U.S. and U.S.-centric stocks and underweight more foreign-exposed ones.
The tech sector’s forward PE is 14.1 times expected earnings, among the lowest of the 10 S&P sectors, Thomson Reuters StarMine data shows. The PE for energy, which has the third-largest exposure to Europe after materials, is 13.1, lowest of any sector.
Meanwhile, one of the least-exposed sectors to Europe, consumer discretionary, sports a multiple of 18.2. The overall S&P 500 is trading at 15.3 times forward 12-month earnings, the most expensive it has been by that measure since the fourth quarter of 2008.
Within tech, IBM’s PE is 9.9, and Oracle’s is 11.7. Hewlett-Packard’s forward PE is 7.5, expanding from around 4 in January, as its stock is up nearly 90 percent this year.
As a region, Europe accounts for the biggest part of overseas sales for U.S. companies, representing about 10 percent of S&P 500 company sales, S&P data shows.
“I would say there’s still upside in these global cyclical companies,” Quinlan said. “There’s room to put money to work still.”
Results from U.S. companies generating the bulk of sales overseas turned the corner in the third quarter, and fourth-quarter results for that group are expected to improve more, thanks largely to Europe, according to Mizuho Securities USA.
“What we began to see in the third quarter was some evidence that the improvement in Europe is filtering through profits here in the U.S.,” said Carmine Grigoli, chief U.S. investment strategist at Mizuho Securities USA in New York.
Based on results from 83 S&P 500 companies that generate 60 percent or more of revenue from overseas, year-over-year earnings declined 10 percent in the first half of the year and were down 0.4 percent in the third quarter. They are expected to rise 3.3 percent in the fourth quarter, Mizuho’s data showed.
That compares with the S&P 500’s 2.5 percent profit gain in the first half and 4.5 percent gain in the third quarter.
Revenue for those 83 companies fell 5.3 percent in the first half and rose 0.3 percent in the third quarter, while it is forecast to increase 1 percent in the fourth quarter.
Moreover, U.S. companies have begun to talk about Europe in a more positive light. Federal Express (FDX.N) and Ford Motor Co (F.N) were among companies citing an improving picture for the region in the latest reporting period.
Ford in October posted stronger-than-expected quarterly results and boosted its full-year global profit forecast based on its European outlook and overseas demand. It said its European unit will be profitable in 2015, earlier than previously expected.
“It’s been a huge shift in the rhetoric and the outlook over the past couple of quarters,” in terms of Europe, said Dan Suzuki, equity strategist at Bank of America Merrill Lynch in New York.
Reporting by Caroline Valetkevitch; Editing by Dan Burns and Bob Burgdorfer