Vanguard FTSE Europe ETF: The end of a lost decade (NYSEARCA:VGK)

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Investment thesis

Although they have been largely stable over the past decade, we have already seen huge rebounds in European equities. From 1995 to 2007, European indices gained 350%. We believe that Europe’s long period of stagnation is over. Avant-garde ETF FTSE Europe (NYSEARCA:VGK) is expected to return 7% per year for the next decade.

Growth in Europe

Over the past decade, growth in Europe has been fairly stagnant, especially when measured in US dollars. Europe has struggled to emerge from the global financial crisis. The continent’s population growth has slowed to a halt. On top of all this, Europe has not been the most business-friendly continent. A recent example is “Royal Dutch Shell” (SHEL) dropping the “Royal Dutch” from its name. The company moved to the UK to avoid political and public pressure surrounding its transitioning energy business.

EPS MSCI Europe in local currency

Earnings per share, MSCI Europe (Yardeni)

The chart above shows earnings per share for MSCI Europe, measured in euros. Despite all the problems, European businesses have survived and grown. Since 1995, profits have increased by about 4.5% per year.

A Relative Comparison

As of April 30, 2022 Vanguard FTSE Europe (VGK) Vanguard S&P 500 (VOO) Vanguard FTSE Emerging Markets (VWO)
PER 13 20 11
P/P 1.8 3.9 1.9
DEER 13% 22% 15%
Dividend 3.2% 1.3%

3.1%

Estimated growth (since 1995)

4.5% seven%

8%

Source: Image created by author with data from Vanguard

What you own

10 Biggest VGK Stocks

Largest holdings of VGK (FTSE Russell)

VGK investors own a good mix of assets, at a fair price.

  • There are high quality companies like Nestlé (OTCPK: NSRGY) and Louis Vuitton (OTCPK: LVMHF). Investors are also exposed to the European energy sector, which benefits from inflation, namely Shell (SHEL) and TotalEnergies (TTE). Pharmaceutical companies are profiting from Europe’s aging population. And, you also own cheap banks like HSBC Holdings (HSBC), which trades below book value. If you go further down the list of VGK holdings, you’ll find top brands like L’Oreal (OTCPK:LRLCF), Mercedes-Benz (OTCPK:DDAIF) and Airbus (OTCPK:EADSF).

Risks

Europe’s working-age population has shrunk as people live longer and have fewer children:

Population of working age in Europe (15-64)

Population of working age in Europe (Fred Economic Data)

This demographic problem could lead to an economy increasingly dependent on the government. On top of that, there is the question of what will happen to income in the future. Adapting to this situation, many of the largest companies on the continent provide basic necessities such as food, energy and healthcare.

Unilever corporate building

Unilever (marketing week)

The war in Ukraine is another threat to European companies. This can hurt businesses in the short and long term. Companies like Unilever (UL) and many others have suspended operations in Russia. These companies are losing a large consumer base and significant revenue. As the economic war continues, Europe is even considering blocking Russian oil imports.

Debt is another risk. European consumers tend to have a very high debt-to-disposable income ratio. They may find it difficult to repay their debts if interest rates continue to rise.

Evaluation

Despite the challenges, we expect Europe to resume its historic growth. Vanguard FTSE Europe (VGK) has earnings per share of $4.46. Earnings growth is expected to average 4.5% over the next 10 years. We do not expect the dollar to outperform the euro indefinitely. Earnings growth of 4.5% translates to 2032 EPS of $6.93.

Given this level of growth, it is reasonable to expect VGK’s multiple to remain at 13x earnings. Our price target for 2032 is $90 per share. With dividends reinvested, long-term investors can expect a 7% annual return from an investment in VGK.

Conclusion

Despite all the noise surrounding Europe and its economy, we are betting on low valuation, a large dividend and stable underlying companies to lead investors to a 7% annual return. An investment in VGK involves risks, especially in the short term. However, we have a buy rating on VGK as we believe it can beat the S&P 500 going forward.

To compare the expected returns of emerging markets and the S&P 500, see my article: IVV Vs. EEM: The S&P 500 will struggle as emerging markets gain.

Mary I. Bruner