Six eurozone value plays

When we screened for value last year ('Watching out for eurozone value', 7 Nov 2011), what we presented was more of a watchlist of quality stocks (28 stocks in total) than a honed screen. The stocks in the portfolio did well overall, rising 12 per cent on average, although this was inferior to the 13 per cent gain from the S&P Eurozone LargeMid-Cap index from which they were selected. This time around we're more focused on finding stocks that provide real buying opportunities, so we've employed the screening technique espoused by contrarian value investor David Dreman.

Mr Dreman's approach is based on looking for stocks with valuations that suggests the market expects little from them, but with fundamentals that suggest far better things. He likes investing at times when sentiment is low and the financial crisis provides a fitting backdrop from that perspective. The screen is interested in stocks that are among the cheapest fifth of the market based on either price-to-earnings ratio, price-to-book value, dividend yield, or price-to-cash flow (defined as post-tax, pre-exceptional profits with depreciation and amortisation added back). From these cheap stocks Mr Dreman requires:

■ Improved EPS growth in the most recent six-month period;

■ Positive forecast EPS growth;

■ A return on equity of over 10 per cent, which acts as a basic measure of underlying business quality;

■ Gearing of less than 75 per cent;

■ A current ratio of more than 1. The current ratio is a measure of easily realisable assets and indicates a business that can cope with the unexpected;

■ An above-average dividend yield;

■ An above-average five-year compound annual dividend growth rate (shorter time periods have been used where a full five-year record is not available);

■ A payout ratio (the amount of available profits that are paid to shareholders as dividends) of less than either two-thirds or the five-year average, which suggests the company is not overstretching itself with the current level of dividend.

Minded by the ongoing uncertainty in the eurozone, we've decided to only look at stocks with market capitalisations of €1bn or more taken from the S&P Eurozone LargeMid and Smallcap indices. The screen criteria puts a lot of emphasis on dividends due to Mr Dreman's belief that the role dividends play in determining outperformance is often overlooked by the market. We've therefore ordered the six stocks that have made it through the screen by highest to lowest yield.

SIX EUROZONE VALUE PLAYS

Oesterreichische Post AG

Austrian Post has begun to show some strain from the slowing European economy and first-half results were slightly below expectations due to falling advertising revenues as businesses cut back on mail shots. But the company still expects profits to rise this year on broadly flat revenue as it cuts costs and makes progress in the growing parcel market and online services. It has also recently divested its Benelux business and is expanding eastwards into Poland and Bulgaria where it sees good opportunities.

SCOR SE

It's not an easy time to be in the reinsurance business given the low-yield environment, economic turbulence and the capital-draining round of natural disasters last year. But French group SCOR has been doing well and continues to deliver on a three-year plan that was set out in September 2010.

Axel Springer AG

German media giant Axel Springer, which owns about 240 newspaper and magazine titles including Germany's best selling tabloid Bild, is suffering from declining print sales as readers move to online publications. But it's large digital business has been picking up the slack and management expects digital growth to more than compensate for weakness elsewhere this year. In fact, a 20 per cent rise in digital media revenues to €279m (£222m) in the second quarter means they now account for a third of sales.

Koninklijke Ahold NV

Dutch supermarket group Ahold faces many of the consumer headwinds that are hampering UK rivals and has recently had to guide market expectations lower for the year. The company has a big US presence and is particularly concerned about the impact of food inflation and falling disposable incomes on the market. Management has introduced a programme to cut costs by about €350m between 2012 and 2014 and revenues are being diversified by a move into online shopping and overseas expansion.

Compagnie Generale DES Etablissements Michelin SCA

Two tyre makers appear on our list, the highest yielding of which is French manufacturer Michelin. In the notoriously cyclical automotive industry, large tyre makers are being viewed as relatively defensive due to their pricing power, geographic diversity, falling rubber prices, the need for vehicle maintenance and past restructuring efforts. All this has been reflected in Michelin raising its medium-term forecasts earlier this month to an operating profit of €2.9bn in 2015 compared with €2.5bn previously. It also now expects 4 to 5 per cent growth in the tyre market come 2014.

Pirelli & C. SpA

Italian tyre maker Pirelli has felt the chill wind of the eurozone slowdown and earlier this year revised down sales guidance. However, its strategy to focus on higher-margin premium tyres has been serving it well and profits are still expected to be on target for the year. The company is also looking to expand its presence in fast-growing economies and this year announced a joint venture in Indonesia to target Asia's huge motorcycle tyre market, started production in Mexico and acquired distribution chains in Brazil and Sweden. Some recent wrangles between major shareholders have also been catching headlines recently.