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Stock Strategist Industry Reports

Shopping for European Banks in the Discount Aisle

Is the market mispricing quality in Europe?

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Heavy clouds of pessimism loom large in certain corners of the European financial world these days. The tales of woe echo from the verdant vales of Ireland, across the sun-drenched plains of Iberia, to the noble monuments to antiquity in Greece. While the bad news has justly punished the wicked among banking stocks in these regions, we think it has also unnecessarily tarnished the righteous. While none of the European banks in our coverage universe are 5-star buys at the moment, many are trading a significant discount to our fair value estimates--and seemingly without much regard to quality. We think the market's apparent lack of differentiation between the winners and the losers is presenting an opportunity for investors with an eye on European financials.

We're highlighting examples from three countries: Spain, Switzerland, and the United Kingdom. We note with some surprise that the banks facing the strongest headwinds in these countries--Banco Popular in Spain, because of its lack of geographic diversification,  UBS (UBS) in Switzerland, because of its damaged reputation, and  Royal Bank of Scotland (RBS) in the U.K., because of its government rescue and ongoing breakup -- are priced at similar or less attractive discounts to fair value compared to their less risky peers. We think that the turmoil in Europe has frightened the market into tying valuations too closely to book values without differentiating between firms. In our opinion, this is an example of the market throwing the baby out with the bathwater, thus creating opportunities for long-term investors.

Erin Davis does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.