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By Jeremy Glaser | 11-16-2010 10:20 AM

Our Top European Stock Picks

Morningstar's Paul Swinand on which European stocks investors should keep on their radar screens and which they should ignore.

Jeremy Glaser: From Morningstar.com, I'm Jeremy Glaser. I'm joined today by Securities Analyst, Paul Swinand, to take a look at some European stock picks.

Paul, thanks for joining me.

Paul Swinand: Thanks for having me.

Glaser: So what's your first high conviction pick for people who are looking for European stock exposure?

Swinand: The first stock I'd like to talk about is VW, the automotive company. The ticker is VOW. We've recently raised the fair value from €110 to €160, and that's based on our forecast of them making better gross margins. To give you an idea of what's going on with the stock right now. They've recently reported that demand has picked up especially in emerging markets such as the BRIC countries.

For example, demand in Russia was up over 50%. In China, sales were up over 30%. At the same time, the stock has been a little bit depressed because first of all they've been investing more in factories and with the global economic crisis sales and margins have been pressured. So in the last quarter, they actually had 500 basis points better gross margins. We think there's still room for gross margins to improve from here, and so we increased their fair value.

The reason the stock is still trading below their fair value is because there is also some additional headwind priced into the stock for the spring. The European countries have incentive programs for the consumers similar to the U.S. Cash for Clunkers program. Those are going to roll off in 2011. So most analysts are thinking that sales will be down 5% or so in the spring, and so the stocks are still under some pressure based on that expectation. We think even if the stocks are down that much, we think that the extra demand from emerging markets will cover up for that and the improved gross margins will help us well, so we think that VW is fairly undervalued at this point.

Glaser: Another pick that you mentioned was Roche, the pharmaceutical giant. Can you tell us why that stock looks attractively priced right now?

Swinand: Right now, Roche is – we believe that it's a wide-moat stock, and that it is trading like a big pharma that has a big exposure to its patent – its pipeline and its patents. So a lot of big pharmas, if they're out of patents, they don't have any more new drugs and then they lose some of their profitability.

Roche is really focused on their biotech business and a lot of their business lines are much more like a biotech company than a traditional pharma company. So for example, they've got a big oncology division. We think that those are better businesses long term. They'll have more growth and better margins. However, there is again some bad news in the stock in the short-term.

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