From Verdad Advisers, April 24:
Swedish Fish
Sweden, the land of ABBA, meatballs, and, of course, the iconic Swedish Fish candy, may not be the first country that comes to mind when you think of global investment opportunities. Yet a new report from quantitative research firm Research Affiliates identifies Sweden as the developed market with the highest 10-year expected returns. And while the Swedish market is small, our internal valuation screens are also finding disproportionate opportunities in the land of lingonberries.
Europe generally is cheap. Today, Europe’s CAPE ratio is 20.4x versus 28.2x in the US, according to data from Barclays. This means Europe’s CAPE valuation today is 28% below the US, a discount that is nearly double the 15% historical average discount since 1981. On the right axis of the figure below, we measure the European discount in percentile terms, as illustrated by the gray line. Today’s European discount of 28% is in the 76th percentile of recorded history since 1981, having recently narrowed from the 95th percentile in October 2022.Figure 1: European Discount Relative to the United States (1981—2023)
Sources: Barclays and Verdad analysis
Wide valuation spreads have historically presaged high future returns. Over four separate two-year periods beginning in September 1992 and June 1996, 1999, and 2003, Europe outperformed the US by 5.7 percentage points per year, on average, as valuation spreads narrowed over the course of two years. And over the six months between October 2022 and March 2023, the European equity market has returned 31.8%, more than double the US market’s return of 14.8%, according to data from Ken French.
Sweden isn’t the cheapest market within Europe. That distinction goes to Poland, another place we believe value investors are finding attractive bargains. Sweden’s CAPE ratio of 20.1x today is slightly below the European market at a 2% discount. But Sweden usually trades at a significant premium to the broader European market. Sweden has a highly skilled workforce, a stable political environment, and a business-friendly regulatory framework, as well as a number of market-leading global companies like Volvo (which today trades at 8x EBITDA), Ericsson (which trades at 5x EBITDA), and H&M (which trades 11x EV/EBITDA). Sweden is also the original home of IKEA (which is privately traded), and the country remains a core element of the company’s brand. In the table below, we present a valuation spread analysis where CAPE ratios for each major European country are measured relative to the 20.4x CAPE ratio of the overall European market. The table is ranked by valuation percentile relative to recorded history since 1981....
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