This Hated Stock Could Double From Here

People don’t call him “The Oracle” for nothing.

Back in May, Warren Buffett appeared on CNBC and said he was investing in Europe. The anchors said he was making a mistake, stating that the euro zone unemployment was high and the economy was on the verge of collapse.

But Buffett insisted: “Europe’s economic problems present a buying opportunity. We’ve been buying some European stocks and companies in the past year. Europe is going to be around.”

There’s no question that things are bad in Europe. The unemployment rate in the euro zone is at record high levels. In countries like Spain and Greece, more than half of the youth workforce is unemployed. There’s no way that investing in Europe is a good idea, right?

When it comes to the stock market, Warren Buffett is usually right. I don’t think this time will be any different.

After a 150% rally in the last four years, U.S. stocks are no longer cheap. Many investors have started to look for an alternative. And they’re finding bargains in Europe.

Signs of a Bottom in Spain

Last year, investment firm Blackstone invested $4.5 billion in the U.S. housing market. It bought 25,000 single-family foreclosed homes and converted them into rentals.

Those were homes that were suppressing national home prices. By removing those houses from the market, Blackstone played a key role in our housing recovery.

Now something similar is happening in Spain.

After the country’s real-estate collapse, the government finally started to take the first steps to detoxing the system. Officials who are managing distressed assets from the country’s real-estate bust announced their first big property deal last week.

They will sell 939 homes to Miami-based private-equity firm H.I.G. Capital for $133 million. This should be the first of many deals.

Last year, the government also set up a bad bank institution, known as SAREB, designed to remove bad assets from banks’ balance sheets. SAREB has been busy buying foreclosed property and bad loans from the weakest Spanish banks.

Once this detox process is done, banks will be in better shape to provide loans and help stimulate the economy. As an investor, you do not want to wait until this recapitalization process is done. The time to buy is now, when things are bad and many people still think Europe will blow up.

Tracking the Money Flow

For the last four years, European stocks have performed worse than U.S. stocks. But things seem to be changing now.

With U.S. stocks no longer cheap, some investors have already started to invest more heavily in Europe, where many stocks remain cheap. As you can see in the chart below, European stocks have been outperforming U.S. stocks since July.

See larger image

Aside from the lower valuation of stocks, there’s something else attracting investors. The European Central Bank (ECB) is doing something similar to what the Fed did back in 2009. Remember when the Fed said it would keep interest rates at 0% for an “extended period of time”?

Well, last month, the ECB did the same. For the first time ever, it gave forward guidance on interest rates. It said it will keep rates at 0.5% or lower for at least 12 months.

We all know what this kind of monetary policy can do to stocks. We’ve seen the huge market rally we’ve had here in the U.S.

I’m not saying all is well in Europe. There’s no denying the economy is in bad shape. But if you wait until the economy recovers, it will be too late. By then, stocks will likely be trading much higher.

You Could Double Your Money With This Hated Asset

One way to bet on a recovery in Europe is by investing in the banks. I know … you think I’m crazy for recommending a European bank. But, keep in mind that U.S. banks experienced a huge rally after the depths of the financial crisis in 2009. Citibank, for example, is up almost 400%.

Once European banks start cleaning their balance sheets, we could see a big rally, just as we did in the U.S. My favorite way to play this trend is with the euro zone’s largest bank, Banco Santander (NYSE: SAN).

Over the last decade, this Spanish bank has averaged a price to book value (P/B) ratio of 2.7. Today, Santander trades at a ratio of 1.3, indicating the stock is cheap. The stock would double from here if it returns to its historical P/B average.

Of course, there’s a good reason the stock is cheap. Nonperforming loans have been increasing in recent years. They now account for 3.3% of the bank’s total assets. This is a high number, but not a disaster. To put that into perspective, Wells Fargo’s is 1.5%.

My point is the stock has already dropped 50% since 2010. A lot of the bad news has been priced in by the market. If you use a 25% stop-loss, you can limit your downside and capture all the upside. As I mentioned, the upside could be 100%.

Santander also pays a dividend yield of 7.8%. So, I think it’s a good way to bet on a recovery in Europe.

Regards,

Evaldo Albuquerque
Editor, Retirement Strategist