The Biggest Stock Bargain in Europe

This country's shares appear far cheaper than its growth prospects warrant

SmartMoney

Poland's stock market has gotten temptingly cheap.

Shares there have plunged 45% over the past year, versus declines of 35% in broader Europe and 3% in the U.S., according to MSCI, a publisher of stock indexes.

The reason: Poland's economy is closely tied with that of the euro zone, where growth has stalled and a Greek fiscal crisis looms. Whereas troubled Spain, Italy and Portugal share a currency with financially strong Germany, in Poland, the free-floating Zloty has lost ground to both the euro and dollar over the past year. And banks like Spain's Santander and Italy's UniCredit do brisk business in Poland, raising fears that a euro-zone banking crisis could spread to Poland.

Concerns like these have reduced Poland's stock market to a price of less than seven times company earnings, making it about half as expensive as the U.S. market, according to MSCI. Poland's market-wide dividend yield has plumped up to 5.6% -- a level associated with only a handful of risky firms in the U.S.

But Poland is in better shape than its stock prices suggest.

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This year, the Polish economy is expected to grow by 2.5% -- slower than last year's 4.3%, but still the fastest rate in the 27-member European Union. Last year, the country ran a budget deficit equal to 5.1% of gross domestic product, while America's deficit was 9% of GDP. This year, Poland's government expects to reduce its deficit to 3.5% of GDP.

The falling Zloty has hurt Polish shares in dollar and euro terms, but it has also kept Poland's economy competitive. Poland is to neighboring Germany a source of low-cost manufacturing in much the same way Mexico is the the U.S. As for bank contagion, an HSBC study published last fall pointed out that subsidiaries of foreign banks operating in Poland get much of their funding from local deposits, which reduces their risk of a funding crisis stemming from the euro zone.

One way to measure a country's projected economic health is to look at the rate its government must pay on 10-year bonds. The rate Poland pays, 5.4%, is now lower than those of Spain and Italy.

Poland stacks up well on growth potential, too. It gets a 5.7 out of 10 on the Goldman Sachs Growth Environment Score index, which uses 18 variables to judge whether conditions are right for sustainable growth. That's higher than any of the fast-growing "BRIC" countries: China and Brazil, both at 5.4; Russia at 4.9; and India at 3.9.

All told, Poland's stock market carries similar risks to euro-zone markets, but the valuations are much lower and the long-term outlook is brighter. Venturous investors may want to buy a small stake in one of two exchange-traded funds that track the Polish market. The iShares MSCI Poland Investable Market Index Fund (EPOL) costs a moderate $59 a year per $10,000 invested, and the Market Vectors Poland ETF (PLND) costs $60.

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