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Buyer Beware With European Bank Stocks

Deep discounts are hard to ignore, but investors should steer clear.

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With many European banks trading at tiny multiples of book value and the word "Grexit" (short for Greek exit) now appearing in mainstream publications, investors may be asking themselves whether all of the bad news (and then some) has finally been priced into these banks' share prices and whether now is the time to buy. While we subscribe to Warren Buffett's credo, "Be greedy when others are fearful," we would exercise caution here.

We have repeatedly warned that European banks require more capital in order to withstand the ongoing crisis. Our analysis of how share prices performed during 2007-11 prior to capital raises shows that markets rarely fully anticipate the negative impact that bank recapitalizations have on shareholder value. Three months before a capital raise, we find that shares are typically priced at a 44% premium to their price on the day of the capital raise.

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