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European Income for 2016

With the U.S. market still near its all-time peak, smart income investors are looking overseas.

Though Europe has been mired in recession for several years, economic prospects are now looking distinctly better.

What’s more, many European companies pay decent dividends, making them attractive for U.S. income investors.

The challenge is finding a solid company with decent liquidity on U.S. markets that also pays a good dividend and is located in an attractive country with satisfactory growth. Luckily, I’m up to the task.

Poised for Growth

Overall, the European Union (EU) is expected to perform better in 2016 than in most previous years.

The eurozone is expected to grow by 1.6% in 2016 according to the IMF, while Britain is expected to grow at 2.2%. Sweden, Ireland, and several Eastern European EU members are expected to grow at 3.0% or more.

Given that these are all relatively rich countries, those growth rates are satisfactory.

In fact, they’re only slightly below the IMF’s 2016 forecast for the United States of 2.8%, which I’d regard as pretty optimistic.

By identifying companies from the faster-growing European countries, we can ensure a comfortable macroeconomic background for our investment’s activities.

And, by investing in the EU, you’re also buying into a more stable macroeconomic environment than the United States currently offers.

Admittedly, the eurozone monetary policy is over-stimulative, with ECB Chairman Mario Draghi buying 60 billion euros ($65 billion) worth of bonds each month, a policy similar to Ben Bernanke’s most expansive “quantitative easing” in 2012-13.

On the other hand, the eurozone budget deficit is expected to have been only 2.1% of gross domestic product (GDP) in 2015, compared to 2.6% of GDP in the United States. And it’s expected to have had a current account surplus of 3% of GDP, compared to a deficit of 2.5% of GDP in the U.S.

That suggests that the euro weakness we saw in 2015 may reverse, and U.S. buyers of European investments may enjoy a currency gain in dollar terms as the euro rebounds.

Go East, Young Man

The problem with buying the faster growth of Eastern Europe is that most Eastern European companies don’t have American depository receipts (ADRs) that trade actively in New York.

As the London market is readily available to them, Eastern European companies seeking capital concentrate their international share-selling efforts on that market, rather than undertaking the draconian requirements of selling to domestic U.S. investors.

Still, opportunities do exist for U.S. investors. And the most attractive country is currently Poland. Its new government, which was elected in October, is nationalist but free-market oriented – the Socialists did so badly in the latest election that they’re not represented in the new Parliament.

Poland also has the advantage of not being a member of the euro, so in a financial crisis like that of 2008-09 it can devalue its currency rather than finding itself uncompetitive. The IMF estimates Poland’s growth at 3.5% in both 2015 and 2016, a very healthy rate by European standards, and its current account deficit is a modest 1.4% of GDP.

To buy Poland, your best alternative is the iShares MSCI Poland Capped ETF (EPOL), which aims to match the MSCI Poland Investible Market Index.

At 2.5%, the income on the fund is a little skinny for dividend investors – but it’s trading at a weighted average price-to-earnings (P/E) ratio of only 12 times, a very reasonable rating for a country with such good prospects. The fund’s expense ratio is a reasonable 0.62% annually, and its market capitalization is $159 million.

Flying High

You can of course achieve a much higher yield than this in European stocks. For example, the Irish company FLY Leasing Limited (FLY) uses the special tax benefits available to leasing companies locating in Shannon, Ireland, and offers investors a yield of 7.3% based on its quarterly dividend.

As mentioned above, Ireland is expected to grow at more than 3% in 2016, and Ireland has built a major specialization in the aircraft leasing business.

However, FLY has some of the same dangers that plague high-yield master limited partnerships (MLPs), which often pay out more than they earn. Although its dividend is covered by operations, FLY suffered a value write-down of $63 million on its aircraft fleet earlier in 2015, which will leave it close to break-even for the year.

Still, the company is trading at a 20% discount to book value, and the dividend is well established, having been paid on a steadily increasing basis in every quarter since 2009.

Finally, for a more conventional, solid income investment, you should look to the United Kingdom’s major grocery retailer, J. Sainsbury Plc (JSAIY).

Sainsbury is increasing its market share against torrid competition because it’s aimed at a slightly richer mix of customers than the discounters. It currently trades at a P/E ratio of 10.3 times historic earnings and 10.5 times 4-traders estimate of 2016 earnings. Finally, it yields 5.2%.

Bottom line: European companies offer U.S. income investors stability, some growth, possible modest currency appreciation, and diversification from the U.S. market. Thus, a few well-chosen European holdings should form part of your portfolio.

Good investing,

Martin Hutchinson