Begin To Invest Fund Spotlight Series – VGK

 

I will frequently spotlight index funds here on Begin To Invest, I think they offer beginning investors and investors of all experience levels the best possible mix of returns, low costs and protection from a serious loss of capital.

 

Today, we are taking a close look at Vanguard’s ETF which tracks the MSCI Europe Index – ticker VGK.

 

Quick facts:

 

  • VGK holds 456 European stocks with $6.3 billion in assets.

 

  • VGK has an expense ratio of just 0.14%, making it one the cheapest ways to invest in the European index that I have found.

 

 

  • VGK has a Price to Earnings (P/E) ratio of 13.6, and a Price to Book (P/B) ratio of 1.4. Compare that to the S&P 500 Index, when has a P/E of 15.3 and P/B of 2.2.

 

The European market is no doubt cheaper, as the debt crisis there has caused a lot of unnecessary panic selling. Given the investing environment, I love some of these big European behemoths. Companies like BP, Royal Dutch Shell, BHP Billiton, Vodafone (see my disclaimer at the bottom), among others which are making billions of dollars per year, with very solid business models, in an economy where Europe is really struggling….all while slowly approaching book value!

 

The “book value” of a company is the value of the company if it were to be liquidated immediately, or generally its total assets minus total liabilities. Of course, it is not a value that should be used to solely evaluate a company’s investment potential, but is useful in combination with assessment of the rest of the balance sheet, income statement and cash flow statement. In times of panic, companies frequently get to book value or below. These periods are usually marked by dramatic drops in the stock market and calls for the world to end, which thankfully has yet to happen. These are times when rational investors can move in and invest in great companies at valuations that are very low.

 

Consider a simple example: A car dealership has 100 cars on its lot and each car is worth $20,000. For simplicity’s sake lets say the car dealer rents the lot, the building and its tools and the cars represent the dealership’s only assets. This gives the dealership total assets equal to $2 million. The dealership has a $1.5 million loan out, that it used to buy all the cars, so the dealership’s book value is $2,000,000 – $1,500,000 = $500,000.

If you could buy the dealership for $400,000 should you? Value investing says yes. This would be an example of a business trading below book value. If the car dealership was for sale for $400,000, it would be a good investment because the buyer knows that they can immediately sell all the cars for more than they were purchased for.

 

 

To get an idea of the kinds of solid companies that are being sold off currently, take a look at the 2011 earnings, cash stockpiles and capital expenditures (CAPEX) of the top 10 holdings for this index fund:

(All Values are in US Dollar, and were converted using the exchange rates below.)

 

Holding FY 2011 Earnings 2011 Cash 2011 CAPEX
Nestle SA 9.5 Billion 4.7 Billion 4.6 Billion
HSBC Holdings plc 16.28 Billion ————– 1.5 Billion
BP plc 25.64 Billion 14 Billion 17.8 Billion
Vodafone Group plc 4.54 Billion (2012) 4.57 Billion 3.05 Billion
Novartis AG 9.12 Billion 3.7 Billion 2.16 Billion
Roche Holding AG 9.34 Billion 3.7 Billion 1.9 Billion
GlaxoSmithKline plc 3.7 Billion 3.6 Billion 591 Million
Total SA 20.4 Billion 11.4 Billion 14.6 Billion
British American Tobacco plc 1.98 Billion 1.4 Billion 327 Million
Royal Dutch Shell plc Class B 30.9 Billion 15.0 Billion 26.3 Billion

 

Exchange rates used to convert Swiss Franc was USD/CHF = 0.97,

Great Britain Pound was GBP/USD = 1.56 and Euro was EUR/USD = 1.23

 

 

I included CAPEX in the list along with the cash on hand to show that many of these companies have enough cash on hand to cover an entire year of capital expenditures if it was necessary. No matter your thoughts on how bad the economy is in Europe, does anyone really think that companies on this list will do so little in sales for the next couple years that they run through this amount of cash? Apparently so, since on average these companies trade at 1.4X book value.

 

 

 

These top 10 holdings make up for 22.6% of the funds total assets. These companies are making boatloads of money, and have large cash stockpiles (and are currently able to add to them with current earnings) to help weather any further economic problems, such as what we are seeing now.  That means $1.4 billion of the fund’s assets are invested in these large companies, providing a very stable foundation for the investor in their consistent earnings and dividends, while smaller companies that carry much less weight in the index and are even further oversold provide potential for capital appreciation.

 

The major concern about Europe, and the reason many European stocks have been sold off, has been due to concerns over the future viability of the Euro. Ironically, more than 50% of the assets of this fund are in companies based outside of countries that use the Euro (36% in the United Kingdom, 13% Switzerland, 5% Sweden to name the top 3). Additionally, a majority of the companies in the fund do business on nearly every continent, which diversifies their sources of income and gives them access to other economies that are in better shape than Europe.

 

Consider some of the large companies in the index and the percentage of sales they do in Europe:

 

Company Name % sales in Europe
France Telecom

34%

SAP

21%

Siemens

53% (1)

Rio Tinto

12.90%

British American Tobacco

23%

GlaxoSmithKline

30.20%

Novartis

26%

BHP Billiton

13.30%

Royal Dutch Shell

39.90%

Alcatel Lucent

29.70%

British Petroleum

66.4%(2)

(1) = Includes middle east and Africa, company does not break down sales in only Europe in 20-F filing with the SEC.

(2) = includes all “non-U.S.” BP only reports revenue breakdown in “U.S” and “non-U.S” segments.

 

 

Just as one example, consider Rio Tinto from the above chart. The stock is down 34% in the last year, while earnings have increased nearly 200% from 2010, and currently earns nearly $3 per share.

 

 

Even if you have to wait for a year or two for the European market to right itself, you are handsomely rewarded by these high dividend paying companies. The fund sports a dividend yield of 4.4%, assuming the payout is equal to last year. For those who are just beginning to invest, finding high quality, high dividend paying investments early and adding to them over the course of a lifetime can result in great sources of passive income and value at time of retirement.

 

 

While researching prospective investments, I was going through a long list of individual European companies, reading further into balance sheets and past annual reports to try and determine potential investment quality of these companies. I decided on this fund (read my disclaimer below) instead of selecting several individual stocks in order to reduce risk in my portfolio. By spreading out my investment over the 456 stocks in the index, I don’t have to worry as much about the effect a single company will have on my portfolio, while still receiving an attractive dividend and prospects for very good capital appreciation.

 

Of course, I or anyone else can not foresee if the problems in Europe are close to over, or how bad it will get. This fund is sitting within 10% of its 52 week low, and did drop down to right around $30 per share in the height of the financial crisis in 2008.  If your portfolio can not handle the potential for this fund to drop back down into the $30 range, this investment is not for you. However, considering this fund is holding so many great companies that continue to make billions of dollars, I think this fund is a great investing opportunity for those who are beginning to invest and who will have the time and patience to invest in it.

 

 

 

My Disclaimer: I “eat my own cooking”, and will invest in some of the index funds or individual stocks that I talk about on this website. I wouldn’t be advising investors to invest a certain way if I could not do it myself in confidence. At the time writing (July 17th 2012), I hold Vodafone (VOD) and Vanguard MSCI European Index fund (VGK) in my personal portfolio.

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  • http://begintoinvest.com Kristin

    I’ve been following your site since you started writing. Enjoy the articles, you’ve definitely done some time-consuming research. Hope you keep sharing your knowledge!

    • Begin To Invest

      Thanks! Glad you enjoy!