Is Spain the Opportunity of a Lifetime…or a Wicked Value Trap?

When I tell readers that Spanish stocks are still cheap, I can’t help but recall Chevy Chase’s 1970s Saturday Night Live skit in which for weeks after his death, Chase announced “breaking news” that “Generalissimo Francisco Franco is still dead.”

Spanish stocks are still cheap, as they have been for over a year, but they have gotten quite a bit cheaper as 2012 has progressed. Spain’s economic woes have become a test of the European Union’s resolve, and judging by the market’s action this year, the EU is failing it and dragging down Spanish stocks in the process.

European stocks were down big on Monday after suffering deep losses on Friday. The catalyst? More bad news out of Spain.

The region of Catalonia—one of Spain’s wealthiest—joined Valencia in what is becoming a long list of regions needing bailout funds from the central government. But more than any specific news, it is the vicious cycle of rising bond yields that is both a cause and a symptom of the crisis.

Spain’s 10-year bond yields rose above 7.5% to a new euro-era high, as did the spread between Spanish yields and German yields. The higher yields rise, the more difficult it becomes for Spain to service its debts…thus causing investors to panic, sell their bonds, and send yields even higher.
Cycles like these are generally only broken by default, devaluation or a bailout. Default is unlikely and devaluation is impossible unless Spain leaves the Eurozone, which I do not view as being likely. This leaves bailout. Spain’s €100 billion banking sector bailout is already in progress, but a full sovereign bailout is looking more and more to be a foregone conclusion. The sooner it happens, the sooner we can all get on with our lives.

For investors, the far more pressing question remains: What does any of this mean for Spanish stocks?

The bullish argument for Spain is compelling. The large, publicly-traded stocks that dominate Spain’s market—such as Sizemore Investment Letter recommendations Telefonica ($TEF), Banco Santander ($SAN) and BBVA ($BBVA)—have globe-spanning operations and get the lion’s share of their revenues and profits from outside Spain. The economic woes plaguing the mother country matter relatively little.

Furthermore, Spanish stocks are shockingly cheap. The IBEX index trades for roughly half its 2007 value and at levels first seen in the late 1990s. Looking at the numbers, we see that Spanish stocks are cheaper than every other major European market—even cheaper than Greek!


Country Dividend Yield P/E
France 4.0% 12.0
Germany 3.4% 12.0
Greece 2.6% 10.3
Italy 4.9% 12.0
Spain 8.1% 9.8
United States 2.1% 15.1

Source: Financial Times

According to the Financial Times’ estimates, French, German and Italian stocks all trade for 12 times earnings and sport dividend yields of between 3.4% and 4.9%. Spanish stocks trade for just 9.8 times earnings and offer a dividend yield, at 8.1%, that is so high it looks like a typo.

To put that in perspective, Spain’s dividend yield could be cut in half and it would still be roughly double that of the United States.

It is truly a strange world in which we live when Spain’s globe-spanning blue chips trade at lower valuations than Greek stocks, which tend to cater to Greece’s weak domestic economy and carry the very real risk that Greece will be booted from the Eurozone.

The problem with my argument is that most of this was true a year ago. The numbers were slightly different, but Spanish stocks were significantly cheaper than most other world indices. That they have continued to get cheaper is a major source of frustration for investors.

The important thing to remember is that Spanish stocks are being driven lower by macro concerns and not by any news specific to the companies themselves. Spain’s large, liquid stocks are being used as a proverbial punching bag because, frankly, they make an easy target.

Is there risk involved in buying Spanish shares at current depressed prices? Of course. One risk I recognize is that paralysis in the Spanish capital markets will make it difficult for a company like Telefonica to raise needed funds (Santander and BBVA have access to the ECB for funding needs, so I am less worried about them). And with Spanish regulators banning short selling in the domestic market, I am mildly concerned that U.S.-listed ADRs will bear the brunt of selling (the ADRs of the Spanish stocks I mentioned are not affected by the short selling ban).

All of these are risks that must be acknowledged. Still, the attractive prices on offer make these risks worth taking. They may get cheaper in the short term, but I see gains of 100-200% over the next 18-24 months as being very likely in Telefonica, Banco Santander and BBVA. I continue to recommend buying all on dips, though be patient and wait for the dips to run their course.

Disclosures: Sizemore Capital is long BBVA, SAN and TEF

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