Diversification away from the U.S.: Five European stock picks

By Conor McCreery
Globe Investor Magazine Online, Nov. 23 ,2007

U.S. markets don't appear to have much going for them, particularly for Canadian investors worried that the weakening greenback might eat their gains. But where should you look if you already have a nicely diversified collection of Canadian equities and fixed income instruments in your portfolio, and you want somewhere else to put your cash, but you're leery of emerging markets?

How about Europe?
John Arnold, portfolio manager at AGF International Advisors, had been adding to his U.S. equity positions, but then he hit a valuation wall.

"When I compare Europe to the U.S.A., if we use P/E ratio, the gap between Europe and the U.S. model has increased 30 per cent," Mr. Arnold says. On valuation terms, you're right to go into Europe."

Mr. Arnold, based in Dublin, shared five names among the AGF European Equity Class Fund's top 10 holdings. The fund has struggled a bit this year, returning just over 5 per cent, but that puts it ahead of its group average. And over the past two years, Mr. Arnold's picks have more than doubled the group average.

BNP Paribas SA (BNP-FR - 68.45 euros)
Mr. Arnold describes it as an "excellent bank." And he while acknowledges it had to write off "quite a bit due to the current nasties," he notes about 70 per cent of its operations are on the retail banking side. Its price-to-earnings ratio, combined with a dividend yield up over 4 per cent, makes the French bank attractive, particularly since BNP has in the past decade been compounding earnings nicely, at about a 20-per-cent pace annually and 21 per cent in the third quarter.

Société Générale SA (GLE-FR - 93.90 euros)
The French commercial bank had a rough third quarter as earnings slipped 12 per cent due to a writedown. It has more exposure to subprime than BNP, but Mr. Arnold figures those charges will amount only to "about 5 per cent" of a good year's profit. "The attraction is the valuation of a good bank," Mr. Arnold says. "[It] is progressively putting its footprint across Europe." He likes its strength in areas such as car leasing and consumer credit.

GlaxoSmithKline PLC (GSK-N - US$47.87)
Mr. Arnold says the British pharmaceutical giant has "reasonable yields and a low enough P/E ratio [4.3 per cent and 12.8 respectively]." And he is optimistic it will be able to bounce back from its brush with the U.S. Food and Drug Administration over its No. 2 selling drug, Avandia. Some observers believe Japan's Takeda Corp. stands to benefit from Glaxo being forced to put a warning on the diabetes drug due to heart attack concerns, but Mr. Arnold says the risk of Glaxo losing market share is less than many have predicted.

Sanofi-Aventis (SNY-N - US$43.75)
The Swiss drug manufacturer caught Mr. Arnold's eye because of the drug Acomplia, which is meant to control obesity but has shown positive results in tests for controlling diabetes. Since most diabetes drugs cause users to gain weight, he says, Acomplia could become best in breed. But Acomplia has been held off U.S. shelves due to evidence it increases risks of depression. Still, Mr. Arnold says, Sanofi's 3-per-cent yield is solid and the drug pipeline may pay off.

Kingfisher PLC (KGF-LN - 163.1 pence)
The British firm, which owns do-it-yourself retailer B&Q, has enjoyed strong growth in countries such as France, Poland and China. "Profits have imploded over the past three years" but Mr. Arnold believes the company is ready to make progress. He expects the slowdown in the British housing market will lead to more people bypassing contractors for do-it-yourself projects. He also believes Kingfisher will soon appoint someone with strong inside knowledge as its new chief executive, succeeding the current CEO, who steps down early next year. Special to The Globe and Mail