September 3, 2024
European bank stocks have climbed more than 25% during the past year as earnings rise. The bloc’s lenders may rally even more amid a surge in stock buybacks and dividends, according to Goldman Sachs Research.
“Pan-European bank earnings have been really good in recent years, but the market doesn’t believe it can continue,” says Sharon Bell, senior strategist on the European Portfolio Strategy team. “They’re being over-penalized at the moment.”
Europe’s banks have several things going for them. They raised large sums of capital following the financial crisis in 2008, which has made them substantially less risky, Bell says. Profits for lenders on the continent and in the UK have been healthy, as interest rates have risen from rock-bottom, or even negative, levels. The companies have also controlled costs, which has helped increase profits: Their return-on-equity (a key measure of bank profitability) has roughly doubled over the past decade or so.
Are European bank stocks a good investment?
European bank stocks are relatively inexpensive, Bell says. They have a price-to-earnings multiple of 6.5x — one of the lowest PE multiples for a sector in Europe. That multiple is near the bottom of the 20-year range for European banks, and it compares with about 15x for the average stock in Europe.
“Structurally, banks have made great strides in the last 10 to 15 years in Europe, which they’re not being rewarded for in their valuations,” Bell says.
Bell points out that European banks are also giving back money to shareholders via stock buybacks and dividends. They’re in a position do so because they’ve amassed enough capital and have strong earnings. There are also signs that European corporate management is more open to stock buybacks than they have been in the past.
“The mentality has changed,” Sharon says. “These are not huge growth industries, so you give the earnings back to the investors.”
Europe’s interest rates are unlikely to return to sub-zero levels
Even so, there are several reasons why investors have been skeptical that bank stocks can climb even higher. Financial companies typically make more money from lending when interest rates are elevated. The European Central Bank and the Bank of England, meanwhile, have begun lowering their policy rates. But Bell and her colleagues in Goldman Sachs Research don’t expect central banks to return to negative, or even ultra-low, rates in this economic cycle.
“Interest rates are coming down, but they’re not going to go down to pre-pandemic levels,” Bell says. “That’s extremely important for banks’ profitability.”
And while GDP expansion is expected to be sluggish, Bell and her colleagues don’t anticipate a deep recession. Goldman Sachs Research’s outlook for economic growth in Europe is higher than the consensus. At the same time, European companies and householders have relatively healthy balance sheets and savings. Taken together, that makes a wave of defaults on bank loans less likely.
“The likelihood of a rise in non-performing loans is low. You’d need a deep recession,” Bell says. “Europe’s problem isn’t deep recession. Its problem is that its economy isn’t growing very much.”
Bank stocks are closely linked to sovereign risk
Another risk to European banks is that their investment prospects are closely tied to the governments of the nations in which they are based. If a government’s bond yields increase relative to those of German bunds, that wobble tends to hit the banks in those countries as well.
The region’s banks also tend to have volatile stock prices relative to the rest of the market (or beta), a feature that is linked to the economic outlook. “They’re penalized for being attached to their sovereign and the long-term potential growth related to the economy,” Bell says.
Europe’s bank stocks could add diversification to portfolios
Bell notes that these stocks have another factor in their favor: Europe’s lenders often have financial services businesses like asset management, investment banking, and financial technology embedded in them. These businesses may have earnings that aren’t as heavily correlated with interest rates, and businesses like asset management may benefit from the growing savings of aging populations.
And while financial regulation reform isn’t the reason Bell and her colleagues are bullish on European banks, any policy steps that strengthen the EU’s capital market union would likely be a boost for the region’s financial companies.
On balance, Bell says investors appear to be underestimating Europe’s bank stocks. She suggests that these equities could help diversify portfolios at a time when markets in the US and Europe are dominated by a handful of stocks. “It does provide a bit of diversification,” she says. “It’s certainly a different type of exposure.”
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