Dear Member,

The sovereign debt crisis in Europe may be presenting opportunities for long-term investors who are willing to take a contrarian stance. Seeking opportunities on the other side of the Atlantic requires more than a willingness to accept short-term risk however it also requires an awareness of one’s limitations.

Knowledge and information restrict one’s ability to properly analyze every investment. Knowledge is your practical understanding of a subject. Information is the facts you have or can access. You can have the knowledge, but not the information, to make a good investment decision. Conversely, you can have access to information, but not the knowledge to apply it.

Many times, investors lack enough knowledge and information to conduct a proper analysis. The current sovereign debt crisis in Europe is a good example. We know that European leaders are trying to prevent the crisis from worsening. We also know there is resistance within individual countries (e.g., Greece and Germany) to some of the potential solutions. What most of us do not know is how the crises will evolve or when a resolution will be reached—nor do we have enough information to predict the outcome with much accuracy.

I am not afraid to admit that I am among those who lack enough knowledge and information to accurately predict what will happen in Europe. I am cognizant of the risks, but any opinions I have are solely based on what the news reports tell me.

What I do know, however, is that crises create opportunities for long-term investors. This is could particularly be the case for non-financial companies headquartered in Europe. They are not likely to be directly affected by the sovereign debt crisis, though fear about a widespread collapse in the European banking sector could be depressing their prices.

With this in mind, I decided to create a screen in our Stock Investor Pro program to see what would be identified. I sought out non-financial European companies whose American depositary receipts (ADRs) were listed on U.S. exchanges. Earnings growth, including positive year-over-year growth for more recently reported quarter, and dividends were required to weed out the weakest companies. Valuations were capped at a price-earnings (P/E) ratio of 20. Finally, I required that the current P/E be below the average P/E of the past five years to increase the odds that the passing companies were trading at bargain prices.

Keep in mind that this is a fairly simplistic and restrictive screen. As such, it is merely meant to be a starting point for further research, with the understanding that other suitable European ADRs may be available.

Foreign Dividend Reinvestment Plans

Many European companies offer dividend reinvestment plans. These programs allow shareholders to use their dividend payments to acquire additional shares of stock. The advantage of such programs is that they allow you to use a form of dollar cost averaging to increase the size of your holdings. (The disadvantage, of course, is that you do not directly receive the dividend cash.)

Three services that facilitate foreign dividend programs were listed in the June 2008 AAII Journal and are still accessible to individual investors.

Do you participate in a dividend reinvestment program (DRP)? Tell us on the AAII.com Discussion Boards.

The Week Ahead

Three S&P 500 member companies will report earnings next week: Yum Brands (YUM) on Tuesday and Costco Wholesale (COST) and Monsanto (MON) on Wednesday. Third-quarter earnings season will “officially” start on October 11 when Alcoa (AA) reports.

The September ISM manufacturing index and August construction spending are the week’s first economic reports, with both scheduled for Monday. Tuesday will feature September auto sales and August factory orders. The ISM’s September non-manufacturing (aka services) index and the September ADP Employment Report will be published on Wednesday. Thursday will feature weekly initial jobless claims. September employment data, which includes the change in nonfarm payrolls and the unemployment rate, will be released on Friday. August wholesale trade and August consumer credit data are also scheduled for the same day.

Two Federal Reserve officials will make public appearances: Richmond Fed President Jeffrey M. Lacker on Monday and Federal Reserve Chairman Ben Bernanke on Tuesday.

AAII Sentiment Survey

Investor sentiment continues to be bearish on the outlook of the market six months out, but a higher percentage of investors are bullish this week in the latest AAII Sentiment Survey. Bullish sentiment among individual investors increased 7.2 percentage points to 32.5%. The increase was the highest single-week jump in the bullish reading since the middle of June. The weekly sentiment reading of investors expecting stock prices to rise over the next six months continues to be below its long-term average of 39%. Bullish sentiment has measured below its historical average for 10 consecutive weeks.

Neutral sentiment, expectations that stock prices will be essentially unchanged over the next six months, fell 6.0 percentage points to 20.7%. This is the 11th consecutive week that neutral sentiment has been below its historical average of 31%.

Bearish sentiment, expectations that stock prices will fall over the next six months, fell 1.2 percentage points to 46.8%. This was the seventh time in the past nine weeks that bearish sentiment has been above 40%. It is also the 29th time out of the last 32 weeks that bearish sentiment has been above its historical average of 30%. While bearish sentiment declined, it remains more than one standard deviation above its long-term average.

Are you bullish, bearish or neutral? Take the AAII Sentiment Survey and tell us.

Wishing you prosperity, and, to our Jewish members, L’Shana Tova,

Charles Rotblut, CFA
AAII Journal Editor

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