European Bank Stocks Are Still Bafflingly Underrated

European Bank Stocks Are Still Bafflingly Underrated
Reda Farran, CFA

over 2 years ago3 mins

  • European bank stocks are starting to rebound, they're cheap, and they're ready to catch up with their US rivals.

  • Throw in the fact that their profits are rising and they'll soon be able to distribute those profits to shareholders, and you’ve got the recipe for big gains still to come.

  • You can benefit from the entire sector’s potential rise easily and cheaply by investing in the iShares STOXX Europe 600 Banks UCITS ETF.

European bank stocks are starting to rebound, they're cheap, and they're ready to catch up with their US rivals.

Throw in the fact that their profits are rising and they'll soon be able to distribute those profits to shareholders, and you’ve got the recipe for big gains still to come.

You can benefit from the entire sector’s potential rise easily and cheaply by investing in the iShares STOXX Europe 600 Banks UCITS ETF.

Mentioned in story

Banks have been among the worst-performing stocks in Europe over the past decade, but the sector’s more than redeemed itself with some of the biggest gains this year. And with so many factors still working in its favor, here are some very good reasons you might still want to buy in…

They’re still below pre-pandemic levels

The STOXX 600 Banks Index – a popular stock market index made up of European bank shares – is up by more than 60% from its September lows. That's its steepest climb since the sector recovered from the 2008 global financial crisis, sure, but the index is still languishing below its pre-pandemic levels.

The STOXX 600 Banks Index is still more than 10% below its pre-pandemic level. Source: Bloomberg
The STOXX 600 Banks Index is still more than 10% below its pre-pandemic level. Source: Bloomberg

They’re cheap

Bank stocks aren’t just cheap compared to their pre-pandemic levels, but next to their American peers and the wider European stock market too. The banks that make up the STOXX 600 Banks Index are currently worth an average of 10x next year’s forecast earnings – 15% less than US banks, and 45% less than the wider European stock market.

They’re ready to catch up with their US rivals

While we’re on the subject, here’s something else worth pointing out: US bank shares recently breached their pre-global financial crisis levels, while Europe’s are still more than 70% below where they were before the crisis. European bank shares, then, could benefit if that performance gap starts to reverse.

There’s a big, widening performance gap between European and US banks. Source: Bloomberg
There’s a big, widening performance gap between European and US banks. Source: Bloomberg

Their lending profits are rising

Rising inflation – both actual and anticipated – is sending long-term government bond prices down (and yields up), since bonds’ fixed future payouts are worth less if the prices of goods and services are ticking higher. That’s pushing up long-term interest rates, boosting the profits banks make from lending to customers. But despite that, the European bank sector’s performance relative to the wider market hasn’t kept up with rising inflation expectations – just look at the graph below.

“Euro inflation swaps 5-year, 5-year forwards” measures investors’ average inflation expectations over a 5-year period beginning 5 years from now. Source: Bloomberg
“Euro inflation swaps 5-year, 5-year forwards” measures investors’ average inflation expectations over a 5-year period beginning 5 years from now. Source: Bloomberg

Their other segments’ profits are rising

It’s not just bank lending profits that are rising, but profits from other activities too. Banks’ trading businesses are benefiting from buoyant markets and booming trading volumes, and their investment banking businesses from record deal-making activity – think initial public offerings and mergers and acquisitions. According to Bloomberg, that led banks’ profit to beat expectations by 40% in the first quarter. If they can bust through expectations again when they report their second-quarter earnings, expect bank stocks to continue to outperform.

They’ll soon be able to offer juicy shareholder incentives

Higher profits raise the prospect of more shareholder rewards in the form of bigger dividends and share buybacks. But due to caps imposed by the European Central Bank (ECB) at the height of the pandemic, European banks are currently restricted from offering just that. Here’s the good news: the ECB is set to lift those caps on September 30th, and the resulting increase in dividend payouts could – according to one forecast – see bank stocks offer 5-6% dividend yields. That’s a very attractive prospect for income investors compared to meager bond yields.

They’re about to benefit from less competition

Europe’s fragmented banking sector makes way for a lot of competition among individual banks, and it’s one of the reasons for the sector’s sometimes low profitability. But we’re finally starting to see some consolidation in the sector, especially in Southern Europe. Italy’s Intesa Sanpaolo, for example, bought domestic rival UBI Banco last year in Europe’s biggest banking acquisition in a decade. Spain’s CaixaBank, meanwhile, merged with Bankia earlier this year.

What’s the opportunity here?

You could research and pick from individual bank stocks, but a lower-risk and easier way to invest might be via exchange-traded funds (ETFs). That way, you can benefit from the entire sector’s rise without making specific bets on any individual stocks.

One of the biggest and most popular European bank ETFs is the iShares STOXX Europe 600 Banks UCITS ETF, which tracks the STOXX 600 Banks Index we talked about earlier. The ETF has a total expense ratio of less than 0.50% and is managed by BlackRock’s iShares, the biggest ETF provider in the world. And with so many tailwinds blowing in the sector’s favor, it might just make a nice addition to your portfolio.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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