Why Smart Investors Love Europe
Kane, Leslie, Medical Economics
Jetting off to Europe can be fun, but these days, you might have even more fun staying home and watching your European stocks do the flying. Spain's Telefonica de Espana stock shot up 81 percent (including dividends) in the year ended May 31; Ericsson Telephone, a Swedish telecommunications company, returned 68 percent; and Royal Dutch Petroleum jumped 33 percent. And those aren't isolated cases: Holland's stock index rose more than 37 percent in the year ended June 1997, and the United Kingdom's was up more than 35 percent for the same period.
"Much of Europe was in a recession during the first half of 1996, but I believe it bottomed out, and European economies are now growing," says Kevin McCarey, portfolio manager of the Fidelity Europe Capital Appreciation Fund.
One reason: Corporate restructuring, which convulsed U.S. businesses in the 1980s, reached Europe in the '90s. Many companies, such as Philips Electronics in the Netherlands and Daimler-Benz in Germany, pared down, cut costs, and boosted earnings.
Continental holdings bring special benefits, but also extra risks
American stocks haven't exactly performed shabbily in the past couple of years, either. So why look to Europe? In a word, diversification.
"Europe's markets behave differently from America's; that independence may help protect your portfolio if U.S. stocks decline," says James Clunie, a money manager with Murray Johnstone International in Glasgow.
This also means, of course, that European markets can slide while American ones rise. Slumps abroad can be more extreme, too, since many European stock markets are still more volatile than those of the U.S. Finland's is 1.9 times as erratic, for instance, and Sweden's is 1.5 times as bumpy, according to Barra, a financial research firm in Berkeley, Calif.
And while a favorable currency-exchange rate could boost your holdings, you could just as easily lose big if the dollar strengthens against European currency.
It's also harder to learn about developments that could alert you to dump your stock. Some European corporations have Web sites on the Internet, and your broker can probably get annual reports, but don't expect as much information as you can get on U.S. companies.
All of this doesn't mean you should write off Europe, just that you need to proceed with caution. Here's how to tap into the continent's hot markets without getting scalded.
How to minimize the risk of investing in European stocks
First, limit your European holdings to about 10 percent of your portfolio, and stick to mutual funds (see page 100) or to large companies that trade on exchanges in the U.S. Big firms are required to follow strict accounting procedures. But smaller companies, which usually trade over the counter, are sometimes more lax. It's acceptable in Europe for a parent company to slough its losses onto a subsidiary and avoid reporting the subsidiary's results. You'd never know that losses are eroding profits.
Buying and selling large-company European stock is easy, if you limit yourself to firms that use American Depositary Receipts (ADRs). These are claims issued by U.S. banks against shares of the foreign company. ADRs trade like stocks and are listed on U.S. exchanges. Their dividends are paid in dollars instead of the local currency.
You're better off with companies that offer sponsored ADRs. Those are initiated by the foreign businesses, which absorb most of the administrative costs. Their issuers follow precise financial reporting methods and usually make corporate information readily available. Unsponsored ADRs, on the other hand, are set up by a U.S. bank or brokerage firm in response to market demand. Investors bear the administrative costs. Unsponsored ADRs don't trade on the New York or American exchange, and their reporting techniques might raise eyebrows. Your broker can tell you whether an ADR is sponsored. …