The gap in corporate earnings between the U.S and Europe is at an “unprecedented” 25 year high, according to UBS, which predicts that profits in Europe are set to rebound to the pre-crisis peak within three years.
Earnings per share (EPS) for European companies are 25 percent below their peak in 2007, while for the U.S. they are 20 percent higher than the 2007 peak.
“We are due some profit growth,” Karen Olney, a strategist at UBS, told CNBC Monday, referring to European stocks.
According to her, European companies can reach peak profit levels by 2016 despite some bearish economists predicting Japanese-style stagnation for the euro zone.
“While there are risks, we suggest it may not be as demanding as some think,” she said in a research note on Monday.
UBS forecasts 3 percent profit growth for this year for Europe’s STOXX 600 index and then 8 percent on average for 2014, 2015 and 2016. That’s compared to trend growth in EPS of 6 percent for the index.
Olney points out that the continent has seen zero earnings-per-share growth since 2010, largely because 60 percent of the market’s earnings today are in a slump. So, an improving European economic backdrop may offer these companies the ability to surprise.
“We don’t think this is such a big ask…earnings haven’t moved since 2010 with profits growing at the slowest pace since the 1970s,” Olney said.
The price-to-earnings ratio – a key tool for investors to help figure out if they are getting the most for their investment – has risen to 12.3-times trailing 12 months’ earnings from 9.6-times for the STOXX 600. The stock market rally in Europe followed comments last year from the President of the European Central Bank (ECB)Mario Draghi, who calmed volatility with the promise to do “whatever it takes” to save the euro.
But UBS predicts with earnings catching up and markets continuing to rally that ratio could fall back to 8.8-times trailing earnings, making European equities look welcoming for investors. At that level, European equities would be at a 35 percent discount to their longer-run average.