Investing World Cup: Western Europe

As my Western European team faces off against South America, I'm expecting a rehash of our defeat of China in the last round -- just with more feijoada and less cha chiang mein. The arguments are roughly the same -- South America sports high growth, while Western Europe has low growth. Western Europe is the tried and true, while South America is the bold and new. So I'm turning once more to the same rationale for investing in Western Europe over any emerging market: strong, cash-producing companies, wide industry exposure, well-regulated markets, and exciting growth at a reasonable price.

Growth and corruption
Let's cede the growth argument to South America. True, Western Europe dwarfs South America so greatly that its "slow" growth produces a real (inflation-adjusted) economic return nearly four times that of all of South America. But if we focus simply on "growth," the law of large numbers puts South America in front.

Region

GDP (Official Exchange Rate) in $billions*

GDP Real Growth Rate*

Value of One Year's Growth ($billions)

European Union

$13,310

1.7%

$226.3

South America

$1,251.8

Country-specific**

$59.9

* Source: CIA World Factbook, 2005 estimates

** By country: Argentina -- 8.7%, Bolivia - 4%,
Brazil - 2.4%, Chile - 6%, Colombia - 5.1%, Ecuador - 3.9%, Paraguay - 2.7%, Peru -- 6.7%, Uruguay - 6.5%, Venezuela = 9.3%. Guyana, Suriname, and French Guiana have an immaterial impact.



But what about the quality of that growth? Transparency International compiles an annual corruption-perceptions index. Lower numbers are better. With the exception of the overlap of Spain and Chile, our big players stratify into two definite camps -- Western Europe on top, with South America far below. In South America, investors must wonder how much of those lower (but faster-growing) economic returns they'll actually get to keep.

Western Europe

South America

Country

Index Ranking

Country

Index Ranking

Sweden

6

Argentina

97

Germany

16

Brazil

62

France

18

Colombia

55

United Kingdom

11 (tied)

Chile

21

Holland

11 (tied)

Venezuela

130

Spain

23

Boliva

117



Buying the out-of-favor
It's a time-tested investing principle: You won't find outsized returns by following the crowd. Much of the recent heat surrounding emerging markets is tied to mining and resource plays, and while I may not be able to declare that those cyclical businesses have peaked, I have no problem saying we're closer to the top than to the bottom. In the resource cycle, you generally must choose between two endpoints. Either an economic downturn wrecks the cycle's upswing, or new capital -- eyeing the tantalizing profits and margins -- enters, expanding supply and crashing the resources' prices. In most cases, stocks tied to those resources follow suit. Investing in South American resources was wise five or six years ago, when everyone was focused on tech. Now the potential returns are meager at best.

Conversely, Western Europe offers a wide industry base to draw from, without leaning too heavily on the resource-sector cycle. Looking for financial firms? HSBC Holdings (NYSE: HBC  ) is a good place to start. Or, since I'm a small-cap guy, how about Kensington Group (LSE: KGN  ) , a U.K. mortgage financier that's grown revenues more than 36% annually for the past five years? It's turned into a near three-and-a-half-bagger over that period, even after a recent sell-off.

Are drugmakers more your speed? Perhaps GlaxoSmithKline (NYSE: GSK  ) is too stodgy -- it's the poster child for a slow-growth behemoth -- but AstraZeneca (NYSE: AZN  ) has done nothing vis-a-vis the market for the past half-decade. As opposed to its stagnant share price, however, AstraZeneca's business has grown at nearly 10% annually, while expanding margins and spinning out gobs of cash. You can buy it today for around 10 times free cash flow.

In comparison, consider the company that everyone trots out when pointing to South American performance: Brazilian airplane-maker Embraer (NYSE: ERJ  ) . Sure, it's a wonderful company, but it's priced lower today than it was five years ago. I'd rather put my money on European Aeronautic Defence & Space, the parent of jet giant Airbus. It's four times Embraer's size, has delivered five-year compounded growth at nearly three times Embraer's rate, has higher returns on capital, and has actually given shareholders a positive return over the past half-decade. On the back of the recently announced delivery delays for the Airbus A380 -- a six-month delay for a product that's not yet a big contributor to Airbus' bottom line -- the company's suddenly out of favor and cheap!

What about trade?
The European Union was established to enhance political, economic, and social cooperation among member states. Trade efficiency allows goods, capital, and people to move within Europe as freely as within a single country. This cannot help making European companies leaner and meaner -- and compared with South America, they're already more productive and profitable. In South America, by contrast, the Free Trade Agreement of the Americas is stalled. It may be a harsh truth, but in this case, the rich nations of Europe are going to get richer.

Western European companies benefit from outsourcing their manufacturing tasks to lower-cost countries and then reaping the profit benefits back home. Sweden's automotive-safety system provider Autoliv (NYSE: ALV  ) has done so with great success. In addition, Western Europe has its own captive developing market, ripe with outsourcing opportunities: Eastern Europe.

Finally, there are growing rumblings that global interest rates will continue to rise to ward off inflation. U.S. Fed Chairman Ben Bernanke may be right, or he may just be flexing his muscles in the new job. Either way, widespread rate hikes will likely crimp developed markets but cripple emerging ones.

At the half .
I actually agree with Stephen that foreign investing -- which means anything outside Canada, for me -- is not an either/or proposition. I only care whether what I'm buying is worth more than what I'm paying for it. In aggregate, the companies of Western Europe fit this description. The companies of South America do not.

Let the Fool's sharpest investing minds take you on a global quest for the world's best stock opportunities with a copy ofThe Motley Fool's International Report.

Western Europe is facing South America in this Investing World Cup second-round match. Go back to the intro page to navigate your way to another part of this contest, and then vote for the region that you think should advance to the final round of the tournament!

Fool contributor Jim Gillies owns shares of Autoliv. He is a member of theMotley Fool Hidden Gemsnewsletter team. Embraer is aMotley Fool Stock Advisorpick, and GlaxoSmithKline is aMotley Fool Income Investorpick.

This article represents the opinion of one Fool and should in no way be taken as the opinion of either The Motley Fool, Inc., or the company in question, or as representative of anyone or anything other than that specific Fool's thoughts. So before buying, do your homework and review The Motley Fool's superbly sportsmanlikedisclosure policy.


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