Greece is the most fundamentally undervalued stock market in the world right now. Analysts at Citigroup (NYSE: C) report that the 10-year, cyclically-adjusted price-to-earnings (P/E) ratio, or CAPE, for the Greek stock market is 2.3.
CAPE is a P/E ratio calculated based on earnings averaged over 10 years, a full economic cycle, and smoothes out the effects of a recession or the sharp rebound that often occurs when a recession ends.[ad#Google Adsense 336×280-IA]Worldwide, the average CAPE is 16.8. Values below 5 are extremely rare and in the past have often been followed by large gains.
In order for CAPE to fall below 5, a severe economic problem is needed, and the economic news from Greece seems to be as bad as possible.
The economy has contracted by more than 15% from its peak and is forecast to decline even more in 2013.
The stock market is more than 80% below its 2007 high.
Stock markets have usually turned up before the end of a recession. If Greece eventually enjoys an economic recovery, then the stock market should turn higher before economists announce the end of the recession.
However, many traders are not comfortable buying when the news about a country is so bad. But there is one stock that offers a way to get exposure to the potential rewards and minimal risks of Greece, along with the safety of investing in Germany, Europe’s strongest economy. This stock could also benefit from trends in the U.S. economy.
Deutsche Telekom (OTC: DTEGY) is a German phone company with significant operations in Greece and the United States. DTEGY is the largest phone provider in Germany and owns 40% of Hellenic Telecommunications, the Greek phone company. The company also offers service in Croatia and Macedonia.
In the United States, DTEGY operates under the T-Mobile name and will begin offering the Apple (NASDAQ: AAPL) iPhone in 2013. It is possible that T-Mobile will be the least expensive service option for iPhone users, especially if the company continues offering its $30 “Unlimited Web & Text with 100 Minutes” plan. This could boost earnings for DTEGY.
Another strategy for growth in the U.S. market is T-Mobile’s push for customers who don’t want a service contract. Company officials estimate that there are 368 million cell phones in use in the United States now and 79 million of those are month-to-month users. Growth in cell phone contracts is expected to average 2% a year over the next five years while monthly plans are expected to grow at 10% a year.
DTEGY has reported a loss over the past 12 months, but analysts expect full-year earnings per share (EPS) to be $0.73 in 2012 and $0.78 in 2013. EPS growth is expected to average 17.6% a year over the next five years. Based on next year’s estimated earnings, the PEG ratio, which compares the P/E ratio to the EPS growth rate, is about 0.83. Some analysts believe a stock is trading at fair value when the PEG ratio is equal to 1. Applying that guideline to DTEGY shows that the stock is undervalued by about 20% (17.6 x $0.78 = $13.73).
The chart shows that a move toward fair value is possible. DTEGY has been moving up after bottoming near $10.50 in November. The stochastics indicator has been moving up with price, confirming the bullish trend. Resistance near $13 a share seems like a reasonable target for this move.
DTEGY could move back to old highs near $13 for a 15% gain from current prices and the company has announced that it will pay a dividend of 50 euros, or about $0.65 at recent exchange rates, in May, which is a yield of about 5.8%.
Recommended Trade Setup:
— Buy Deutsche Telekom (OTC: DTEGY) on a breakout above $11.50
— Set stop-loss at $10.50
— Set initial price target at $13 for a potential 13% gain in six months, or 18.8% assuming the company pays the dividend as expected