Changes to this top portfolio imply 20% upside

With stockmarkets still in buoyant mood, the question of whether valuations are becoming (or have already become) overstretched is a recurring theme.

While commentators disagree about the answer, a general consensus is that valuations in the US look full, but that Europe is still attractive, certainly relative to its noisy neighbour across the Atlantic.

The S&P 500 has been running at record high levels for around a year now and has been above 2,200 since December. Speaking at a recent event, Andrew Pease, global head of investment strategy at multi-asset specialist Russell Investments, explained why he thinks the US market, while still not as expensive as back in 2000, is "still very expensive".

Earnings per share (EPS) growth of 10% looks "too much", he explained, and it's hard to see policy being a tailwind for stocks going forward, with the potentially business-frendly policies of President Trump offset by hawkish Fed chair Janet Yellen.

Still, elsewhere Pease says he is "super positive" on Europe, with earnings appearing much more sustainable versus the US. This view tallies with many others, including that of broker Barclays.

Analysts there have just published their latest European Top Picks portfolio, a basket of 26 companies they rate as 'overweight'.

"Our analysts and strategists are in agreement that equities remain an attractive asset class," says Barclays. "Our European equity strategy team still thinks Euro area stocks are undervalued, and would also be buying domestically focused UK stocks."

Expect further equity outperformance in the coming periods, it says, calling the asset class as "the least unattractive investment in a world where valuations are all reasonably rich… and alternatives to risk assets such as cash remain all but uninvestable".

The current portfolio, whch highlights interest in UK homebuilding, small and mid-cap leisure, transport and capital goods, provides average potential upside of 20% to Barclays' 12-month price targets and offers an average dividend yield of 3.2%.

The combined forward price/earnings (PE) ratio is 14.7 and EPS growth estimates are for 12.4%. That compares with 14.6 times and 7.6% respectively for the Stoxx Europe 600 index.

There have been a number of changes since the previous check in March. Most have been driven by constituent's achieving target prices, rather than any reduction in analyst conviction.

Here are some of the most interesting movers.

Countryside Properties and Crest Nicholson

The change that really caught our eye was in the housebuilding sector. In fact, it was two changes - or a double switch, if you will.

After an unjustified period of underperformance from IPO in February 2016 until April of this year, where it traded pretty much flat save a momentary surge last May that was tempered by the Brexit vote a year ago, Countryside Properties has finally come of age.

Progress accelerated in April 2017, driven by a strong first-half trading statement and, since the 5th of that month, the share price is up 40%.

Barclays brought the self-styled urban regenerator into its Top Picks portfolio on 17 May, when it was trading at around £3. It's up 15% since. Currently trading at 343p, analyst Jon Bell is not messing about, taking profits and rotating out of the stock.

While Countryside has not quite hit his target price of 353p, it's only 10 pence away, it's still proven a great call by Bell who is now switching into Crest Nicholson, the housebuilder that initially made way for Countryside last month. The switch back happened on 20 June, just 34 days after the original swap.

Crest's shares have fallen back over recent weeks as more members of the Monetary Policy Committee vote in favour of interest rate rises. But Bell thinks any rate rises will be orderly and, with fundamentals remaining supportive for Crest, the sell off has been "too aggressive".

Tailwinds include attractive land-buying conditions, mortgage lenders being open for business and UK unemployment at a 40-year low. "As Crest's exposure to higher-end London is modest, we believe a 2018 PE of 7.4 times and price/tangible net asset value of 1.6 times (given return on average capital employed of 24%) is attractive."

Bell puts a price target of 628p on Crest, derived using a three-year free cash flow yield of 10%. Using a further 100 basis point reduction on this yield gives an upside case of 713p.

A prospective dividend yield of 6.7%, covered a healthy two times by earnings, is also "highly attractive".

BP

We reported at the previous quarterly review that BP had been removed. Well, that didn't last long and the oil major was added back to the portfolio on 3 May, just over a month after its removal.

The catalyst for BP's return looks to have been first-quarter 2017 results that beat analyst forecasts, with a return to quarterly profit buoying analysts and investors alike. Barclays' Lydia Rainforth puts the firm as her top pick in the European Oil space.

BP shares have traded in a tight range roughly between 440p and 480p since February, pulling back from 520p at the turn of the year. But Rainforth thinks they're worth 625p on a 12-month view, implying upside of 37%. Music to investors' ears, no doubt, having not seen those levels since 2010.

Upstream momentum, built up thanks to three project start-ups so far this year, should only grow through 2017-18, Rainforth says, and the group has ambitious targets set for the downstream business.

"There will doubtless be bumps in the road over the coming five years and assuming flawless delivery is unreasonable for any oil company - yet the direction of travel is far clearer for BP in our view than it is for others under our coverage."

An upside case of £8 assumes the Brent oil price recovers to $85 per barrel by 2019 - seems a long way off currently - and that half of the downstream upside gets delivered. 

For now, a re-rating predicated on an improvement in investor confidence in BP's ability to sustain and grow its 7% yield should suffice.

Elsewhere, we've previously outlined Barclays' case for WH Smith replacing Cineworld, with the only other change of interest regarding London-listed shares being the removal of energy supplier SSE.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.