A Stock v ETF Investment Dilemma: Part 1

The past couple of weeks I have been closely watching the stock markets, wanting to take advantage of the European crisis and buy some stocks on a significant pull back or even a firesale if the situation seriously unravelled. In preparation I put together a list shares that I would like to buy that fulfilled one or more of the following criteria

i) global brand or market
ii) large cap value
iii) strong and consistent dividends.

Some of the companies on the list are based in the US but my focus was really on Europe as this is the epicenter of the current macroeconomic problems and would hopefully result in an ‘overselling’ of stocks in quality European companies.

To see how current events have been affecting european equitie,s let's take a look at the two charts below which show the German (DAX) and Spanish (IBEX35) stock market indices over the past year.

Although it never fell to the lows reached in Sep 2011 the DAX it did fall about 14% from the recent highs. This got me curious as to whether I could purchase large blue chip companies from the strongest economy in Europe at a cheap price.

The IBEX on the other hand reached new lows not seen since 2003, even beating those during the height of the financial crisis in 2008/2009. This index is highly weighted in financials and fears over the Spanish banking system can be clearly seen in its performance. I wanted to know though if other quality stocks had been unfairly dragged down to cheap valuations. 

With this is mind, the watch list I put together is shown below with some current valuation ratios (Reuters)



Unfortunately global brands Coca-Cola, Danaone, Diageo, McDonald’s, Nestlé and Unilver never really fell that much in price to make their valuations attractive. Good companies but not cheap prices. This also convinced me that the latest European crises was not yet causing a full blown bear market, despite what the headlines seemed to suggest.

Microsoft’s share price hasn’t shifted that much either but with it’s current valuations ( including price/free cash flow 12) it already looks cheap and very attractive. The dividend isn’t out of the ordinary at 2.8% but is growing year on year. This is a stock I was ready to pull the trigger on.

After looking through large cap German stocks I picked out two possibilities, the chemical company BASF and technology conglomerate Siemens. These two stalwarts of the German economy have low valuations in a market that is undergoing a sell off because Spain’s debt problems. Could they go down more? Of course, but would they still be around in 5 years time generating sales and cash flow for shareholders - most likely! These are the type pf companies I want to earn shares in.

Volkswagen AG also came to my attention but a bit later. The valuations of this stock, e.g. P/E 3.6, send a possible warning signal that this car company is in dire trouble. However, I could not find any clear reason why this global brand is so beaten up (seeking alpha). Further analysis shows the forward P/E from 2012 earnings is a more acceptable 8, perhaps things are so bad afterall. Just last week Volkswagen announced the purchase of Porsche for around $4.6b.

Sanofi is a Franch based global pharmaceutical company and one of Warren Buffetts higher profile holdings (see a recent valuation on ZeroSum). The valuations look attractive with a price to free cash flow x12 and a nice little dividend of 4.5%. Unfortunately, the stock price has been up the whole month of June, possibly as a result of sector rotation to more defensive stocks to weather the current storm. I decided to wait and see on this one, as it currently sits close to its upper three year trading randge of $30 - $40.



Next come the high dividend telecommunication stocks, France Telecom and Telefonica, paying 14% and 17% respectively. Quite frankly these are extremely high dividends and result in reported payout ratios (90% & 127%) that are probably unsustainable. In fact France Telecom shareholders have recently voted against a proposal to lower the dividend by about 30% to 1 euro per share (Reuters). Who knows what may happen in the future but even so, at current prices the yield would still be around 10%, not to be sniffed at!

Both have companies have exposure outside Europe (e.g North Africa and Latin America) and could be viewed as boring utility stocks that have had their stock prices temporarily depressed by the European sovereign debt crisis. Neither are obviously without their risks but I think one or both of these are worth investing in as part of a diversified portfolio.

Banco Santander is the only other stock that I might be interested in from the Spanish stock market that I can purchase on the NYSE. It has price/tangible book ratio of 1.6, P/B 0.6 and has operations outside Spain such as UK, Portugal and South America. One must remember with banks though is whether their book value can be trusted. A deeper analysis is required to detemine whether a good safety of margin is possible with this stock.

If, however, the market has overestimated Spain's debt problems and the impact on its banks then one would expect this stock to rebound signifcantly (at one point last week it was up 10% but has since fallen again). The flip side of course is bankruptcy or more likely, a government takeover of Santander and a wipe out of shareholders.

My next step was to put a strategy in place to protect against downside risk and loss of precious capital. One simple way would be to set a stop loss of say 25%. This would automatically sell my shares if the price fell by that amount and remove any emotions from the trade.

However, with the current volatility this would probably make the stock purchase more of a short term trade rather than a long term investment. In fact, if the price were to fall 25% I want to be in a position to not only have the confidence the stock will recover but even better, to think it’s a buying opportunity and purchase more!

What I cannot know for sure is whether I will time my trades correctly, so I must have a strategy in place to be prepared for a drop in price which may last a significant period of time. I believe there are two potential defences for the individual investor to act against this possibility, patience (wait it out) and averaging down, to take advantage of the cheaper share price.


Without a deeper security analysis beyond the brief valuations shown, I would simply not have that confidence to double-up on these stocks. To be honest if I bought Volkswagen or Banco Santander and they they dropped 30%, I’d be out and very quickly. It would mostly likely be a value trap and I’ve missed something critical.

A possible alternative is the dreaded word to some value investors ‘diversification‘ aka ‘diworsification‘. This reduces stock specific risk and dampens the losses if one of the companies goes off a cliff. The problem with this approach however for a small investor such as myself is transaction costs.

For example, Nordnet charges $13 (90 SEK) to buy/sell US equities, so say I wish to purchase 4 stocks (e.g. Microsoft, Siemens, France Telecom and Telefonica) and limit commissions to to a total of 1%, I would have to invest 72000 SEK (total commissions = 90 x 2 x 4 = 720 SEK). That’s significantly more cash than I wish to commit at the moment.

This prompted me to look into what ETFs are available as an alternative, which would  give me the desired ‘protection’ of diversity without the extra costs. By being a basket of stocks the ETF would also give me the confidence to buy more if the price dropped significantly.

Part 2 of this blog entry will describe which ETFs are potentially of interest based on my wish list and the type of stocks I aim to invest in.