Best European Stocks to Buy Now

Five years after the financial crisis took its toll across the world, Europe is ripe for investors as the continent’s recovery gets under way. The euro zone, made up of the 17 nations that officially adopted the currency, emerged from recession earlier this year. Although economic growth was slight during the second quarter, it was the first expansion in 18 months, a promising sign.

Worries in the U.S. make Europe an attractive alternative for investors. U.S. stocks have reached record highs, raising questions about the longevity of the bull market. Uncertainty over the government’s handling of the budget and debt ceiling persists. And although the Federal Reserve and the European Central Bank have both vowed to keep interest rates low to spur economic recovery, the Fed is expected to taper some of its stimulus efforts in the months ahead. The accommodative monetary policy of the ECB is a key driver of European performance, says Alec Young, a global equity strategist at S&P Capital IQ.

Momentum is already shifting. The MSCI Europe index, a broad benchmark of large stocks, topped the 12.1% gain of Standard & Poor’s 500-stock index by 1.1 percentage points over the past six months. Yet European stocks, valued at 13 times estimated 2014 earnings, are relatively cheap compared with the forward price-earnings ratio of 15 for U.S. stocks. Global money managers are now overweight in European stocks, according to a recent survey by Bank of America Merrill Lynch. About 60% of European fund managers expect the region’s companies to increase earnings over the next year. (Returns and share prices are as of December 5.)

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Despite stock gains and improving economic data, challenges remain in Europe. Spain’s unemployment rate is a staggering 26%. Greece is still struggling to come out of a six-year recession. Political upheaval in Italy has not helped its debt problems. But the overall recovery in Europe is real, and lagging nations are expected to make up ground over the next few years. Here are five European companies that are expected to benefit from the blossoming recovery. Symbols and share prices are for American depositary receipts.

Bank on financials

It was no surprise the crisis hit the European financial sector hard. Many banks held sizable amounts of government debt from the troubled euro-zone countries. Some banks failed and bailouts were needed. But the financial system in Europe has come a long way over the past few years. Government bonds have stabilized, the European Union continues to enact banking reforms, and the ECB is holding down interest rates to promote growth. Two banks set to prosper during the recovery are Lloyds Banking Group (LYG) and Banco Santander (SAN).

Lloyds, an industry stalwart based in the United Kingdom, may have fared better during the global meltdown had it not bought HBOS, a struggling fellow British financial firm. Shares of Lloyds plummeted from $19 when the deal was announced in September 2008 (just two days after Lehman Brothers filed for bankruptcy) to less than $3 after the takeover was completed in January 2009. After a number of bailouts by the British government, Lloyds did some damage control of its own. It has closed the worst businesses of HBOS and has written down bad assets.

Lloyds, which posted a loss for 2012, is making a comeback as the powerhouse retail bank it once was, says Morningstar analyst Erin Davis. Its business is concentrated in the U.K., where the economy and housing market are strengthening. Lloyds, rated the top British bank stock by Morgan Stanley, is expected to turn a profit of 4 cents per share this year. Analysts expect earnings to grow 45% annually over the next three to five years now that the bank has returned to profitability. At $5, Lloyds sells for 13 times estimated 2014 earnings, in line with the financial stocks in the S&P 500.

Banco Santander, the largest lender in Spain, made it through the recession relatively unscathed despite the significant—and lingering—damage to the Spanish economy. It helped that the 156-year-old bank diversified outside of Europe decades ago and has become a major institution in global banking. Latin America, particularly Brazil and Mexico, now accounts for roughly 50% of Santander’s profits. About one-third is still generated from Europe, half of which comes from Spain.

Shares of the stock are 50% below their five-year high. At $9, Santander sells for 13 times estimated 2014 earnings, on par with U.S. financials. After the bank posted strong profits in the third quarter, analysts now predict earnings will expand by 33% annually over the next three to five years.

Count on the consumer

As consumer confidence teeters in the U.S., sentiment across the Atlantic continues to improve. That’s good news for multinationals based in Europe that get a significant portion of their revenues from their domestic customers. As the European recovery continues, these three companies are set to benefit from Europe’s rising consumer spending.

Electrolux (ELUXY), one of the largest household appliance makers in the world, remained profitable during the worst of the financial crisis. More recently, the Swedish company has been benefiting from the U.S. housing recovery, as more than one-third of its earnings came from North America in 2012. Business in Europe, which contributes about 20% of profits, is expected to grow over the next few years. Electrolux, known for its namesake washers and dryers and brands such as Frigidaire, sold more than 40 million products around the world last year.

Analysts expect earnings to increase 10% annually over the next three to five years. At $48, Electrolux trades at 13 times estimated 2014 earnings, in line with competitors such as Whirlpool (WHR). Andre Kukhnin, an analyst with Credit Suisse, rates the stock a “buy” and predicts the share price will rise 22% over the next year. (Kukhnin’s 12-month price target is based on Electrolux stock listed in Sweden and priced in krona.)

Spanish fashion retailer Inditex (IDEXY) operates more than 6,000 stores worldwide and is growing its e-commerce presence. Globetrotters can find its flagship chain, Zara, in almost every major city of the world. The core market for Inditex is Europe, which accounts for two-thirds of its sales, but the company is also expanding into emerging markets. Regarded for its expertise in so-called fast fashion—the ability to rapidly design, produce and distribute trendy-yet-affordable clothing—Inditex is poised to benefit as the European recovery picks up steam.

Look for the retailer’s profits to grow 11% annually over the next three to five years, according to analysts’ projections. Raymond James analyst Cedric Lecasble believes the stock will outperform the broad European market over the next 12 months. At $31, Inditex sells for 25 times estimated year-ahead earnings. That is in line with its biggest competitor, Swedish clothing company Hennes & Mauritz (HNNMY). (Inditex’s forward P/E is based on the company’s Spanish stock, which is priced in euros.)

Pernod Ricard (PDRDY), the second-largest spirits company in the world after Diageo (DEO), never lost money during the global recession, and its profits have been on the upswing since 2011. Its growing business in emerging markets made up for stagnant sales in its home base of France and the rest of Europe. The company boasts 36 popular brands including Absolut vodka and Chivas Regal whisky.

Melissa Earlam, an analyst for UBS, rates the stock a buy and expects its price to gain 17% over the next 12 months. Analysts estimate that profits will improve 8% annually over the next three to five years. Pernod Ricard trades at $22, selling for 17 times forecasted earnings for the fiscal year ending June 2014, cheaper than competitors Diageo and Constellation Brands (STZ). (Pernod Ricard’s forward P/E is based on the stock price in France, the company’s home country, where shares are priced in euros.)