Investment opportunities in Spain: The five hidden gems

As Spanish equities are battered to the ground and as the problems keep building up, few see an end to this market turbulence. My experience tells me that this kind of market environment usually hides great opportunities or hidden gems if you like. The key strategy is: not to try to catch falling knifes but rather stick to sound fundamentals and buy into companies that can show a relative strength in share price compared to the underlying benchmark.

With rallying bond yields, negative economic growth and uncertainty about the European continent as such, this is my take on how to identify the “hidden gems of Spain”. The approach is pretty straight forward and based on three criteria: Low financial risk, reasonable valuation and growth. Therefore in this screening we exclude financials stocks since the outlook for especially banks is too uncertain. Applying these conditions to our Stock Screener yields the result below, chart 1.

The five companies (Amadeus IT Holding, Distribuidora Internacional de Alimentacion, Endesa, Inditex, Tecnicas Reunidas)in the screening result are all members of the IBEX 35, chart 2. Although the individual share price performance is not impressive for all of the stocks they individually represent interesting fundamental characteristics that will provide a proper risk/reward in the current unstable stock market environment.

If we look more closely at these five companies as a portfolio, both market cap. and equally weighted, we find that their share price performance has diverged since March last year. The relative strength of this “hidden gems” portfolio is an important finding. In the last year the IBEX 35 has lost roughly 40 percent of its value while the portfolio of “hidden gems” actually has preserved its value, highlighting the high relative strength, chart 3.

In terms of the valuation of both IBEX 35 and the “hidden gems” portfolio, the latter is at the low-end based on 12 months forward price-to-earnings (P/E), chart 4. The valuation spread between the two are however close to the 10-year highs. The current high is from the end of 2008/beginning of 2009, when most European equity markets turned around. Please note that since then the “hidden gems” stocks have outperformed the IBEX 35.

I believe that, regardless of how tempting it might be to go “bottom fishing”, this is the time to focus on stable fundamentals and invest in companies with a proven relative strength. The “hidden gems” portfolio is an example of such equities, although you can alter screenings in the Stock Screener based on your own ideas.