Despite the surprise outcome of the recent British parliamentary election, investors contemplating what could have been during a spring of political risk events should feel relatively comfortable about where we are as we head into the summer. With the specter of the French election, the major European political risk event for the year, firmly in the rearview mirror without an extreme-left- or right-leaning president, investors should be able to look past headlines and focus on the fundamentals of European equities. We are far from the only ones coming to this conclusion, as a recent cover of Barron’s even said to “Buy Europe” in the headline.1

Operating Leverage: Top-Line Growth to Bottom-Line Profits

One reason to look outside the United States is based on developed markets outside of the U.S. exhibiting higher operating leverage—which means that growth in sales translates to earnings in a bigger fashion.

Operating Leverage Has Favored the Eurozone Relative to the U.S.

Operating Leverage US vs EU

  • These charts show how changes in median sales growth transferred through the income statements of the index constituents—in aggregate—into bottom-line earnings. In the eurozone, the median earnings growth to sales growth ratio was much higher than what we saw in the U.S. over this 22-year period. 
  • Margins Have Favored the U.S., but Margin Growth May Favor the Eurozone

    Trailing 12-Month Net Margin (4/30/1995–3/31/2017)

    Trailing 12-Month Net Margin

    Margin Reversion to Mean?

    The U.S. has certainly experienced very strong profit margins relative to other regions for the better part of a decade. But there are questions about how sustainable these levels are—or whether they can meaningfully improve from current levels. If the eurozone can begin to grow its profit margins faster than the U.S., that’s something that would tend to favor allocating to eurozone equities over U.S. equities. 

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