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Don Reed, CEO of Franklin Templeton Investment Corp. (JENNIFER ROBERTS For The Globe and Mail)
Don Reed, CEO of Franklin Templeton Investment Corp. (JENNIFER ROBERTS For The Globe and Mail)

Traders

Top tips for picking the best European stocks Add to ...

When he gazes out over the disarray that is European stock markets, Don Reed sees an enticing opportunity in beaten-down share prices – and those oh-so-generous dividends. Although prices have bounced off their recent bottom, European stocks still offer some eye-popping yields. Portugal Telecom, for example, at 13 per cent, or Spain’s Telefonica S.A. at 8.2 per cent.

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But opportunity also means risk – so investors eyeing Europe must be discerning.

Mr. Reed is chief executive of Franklin Templeton Investment Corp. in Toronto and portfolio manager of the globe-traversing Templeton International Stock Fund, whose mandate is to seek value outside of Canada and the United States. He developed his fearless approach to global investing from the late and legendary Sir John Templeton, founder of the Templeton Growth Fund.

“Europe is probably one of the better places to look in the world for yield right now,” Mr. Reed says. “The question is, are you going to be paid that yield?”

Yields that are too high point to danger, the veteran money manager says. Two-year Greek notes were yielding 68 per cent recently; German notes 0.9 per cent, he points out. Clearly, the market deems the higher bond yield to be unsupportable.

While the bond illustration is extreme, discrimination is key when picking through beat-up stock markets such as Europe.

In choosing his investments, Mr. Reed skirts the troubled countries, often called the PIIGS – Portugal, Italy, Ireland, Greece and Spain. So instead of buying Portugal Telecom, with its 13 per cent yield, he bought Telenor Group, the Norwegian telecom company – “Forty per cent of its business is outside the euro zone and the dividend yield is 4.2 per cent.”

As a value manager, Mr. Reed emphasizes that he wants more out of a stock than just yield. His goal is long-term capital appreciation. But generous yields make waiting for a rebound less painful.

At Mawer Investment Management Ltd. in Calgary, analyst Peter Lampert also sees value in European stocks. The Mawer World Investment Fund recently won Lipper Awards for its three-, five-, and 10-year performance in the international stock fund category.

Like Mr. Reed, Mr. Lampert looks for more than high dividend yields.

“We invest in companies with strong business models that generate high cash flow,” he says. “If the dividend is high today, it should be sustainable.”

Mr. Lampert’s top European picks are Vodafone Group PLC and GlaxoSmithKline PLC, both British companies, and France’s Total S.A., a multinational oil company.

“They’re all very global companies that just happen to be headquartered in Europe,” he says. Vodafone has mobile telephone networks around the world, he adds. Its dividend yield is 5.1 per cent, which he believes is sustainable. “The company is well positioned to grow and the management team is focused on maximizing shareholder value.”

Like telecoms, pharmaceutical companies such as GlaxoSmithKline are considered defensive stocks because they generate stable cash flow, Mr. Lampert says. Management is shifting from a heavy emphasis on research and development to selling existing patented drugs in emerging markets. The dividend yield is 4.5 per cent.

Total, the French-based oil giant, yields 6.1 per cent, compared to 2.3 per cent for U.S. multinational Exxon Mobil Corp. “The stock offers very good value,” Mr. Lampert says. Management has a “great track record of earning high returns on capital and paying out dividends to shareholders.”

Mr. Reed of Templeton has found other bargains in Europe, all stocks he has bought for his fund.

“If I’m going to buy some European stocks, one of the things I like is a dividend that is increasing over time,” he says. He found it in a giant Swiss bank, Credit Suisse, yielding about 5 per cent. “If the stock doubles and the yield falls to 2.5 per cent, I’m not going to be too unhappy.”

Another company he favours is British-based BAE Systems, one of the largest defence contractors in Europe, which does 30 per cent of its business in Britain and Europe and 70 per cent elsewhere. “They have a huge contract with the Saudis where they service their fleet,” he explains.

BAE operates mainly on a cost-plus basis rather than fixed-price contracts, which helps it avoid cost squeezes. “They’re well diversified and they’ve raised their dividend every year at least for the last 10 years,” Mr. Reed says. The yield is more than 6 per cent.

He also has invested in Sonafi, a French pharmaceutical company with a yield of about 5 per cent, and Novartis A.G., a Swiss-based pharmaceutical company with a yield of more than 4 per cent.

As well as yield and prospects for capital gain, owning some blue-chip European stocks adds diversification to often Canadian-heavy portfolios, fund managers say.

But what about the euro risk? Could the euro zone break up and the euro be subsumed by the national currencies it replaced?

“I don’t see that happening,” Mr. Reed says. “I guess what I’m wrestling with is how they could even do it.” Greece will likely default on its debt, but the euro will likely survive, he adds.

Currency problems are “something to be aware of,” Mr. Lampert says, which is why it is important to buy shares of European companies that are diversified globally: not all their cash flow is in euro.

“The way we look at investing, we’re looking at individual companies,” he says. “We have a consistent investment philosophy. We’re bottom-up investors, but certainly the macroeconomic environment plays into this thesis.”

Indeed, macroeconomics led Mawer to sell Telefonica shares in July because of the weakening economic environment in Spain.

“I think individual investors should be talking to their advisers, making sure they steer clear of companies whose dividends are too high,” says Mr. Reed. “Buy value, but buy good companies first.”

Good companies are those that pay a good dividend and have cash on the balance sheet, growing earnings, good management and “hopefully have a global tilt, so not all their eggs are in one basket.”

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