Investor: So far, the third-quarter has been quite good for equity investors, as markets have slowly recovered from the correction that began in May. During May, June and early July, equity market volatility jumped as many market participants sought to reduce exposures to risky assets.
Since then, market volatility has gradually reduced in tandem with the recovery in share prices and is now back to the calmer levels of the first four months of the year. The Iseq Overall index is now back to showing a healthy positive year-to-date return, as are the majority of European equity indices.
The Irish financial sector has had a particularly good run during the third quarter, more than making up for some under-performance earlier in the year. Amongst international investors, there is a healthy scepticism regarding the durability of the current phase of the Irish economic boom.
In particular, the heavy reliance on the construction sector is the subject of keen debate, amongst both international and domestic investors. In any modern economy, the construction and broader property sectors account for a large proportion of economic activity.
Furthermore, the underlying economics of this sector mean that it has a voracious appetite for financial services. The funding of commercial and industrial property developments, whether large or small, requires large-scale funding by the financial sector throughout project lives that can often stretch over many years.
A cornerstone of the residential property market is the existence of a well-developed mortgage market. Home purchase also throws off demand for a range of other financial products such as mortgage protection and general insurance products.
With the private sector becoming increasingly involved in public/private partnerships, big infrastructural projects are also generating demand for financial services on a large scale. Given this ongoing construction and property boom, it is therefore not surprising to find that all of the Irish financial stocks have been reporting record profits. In September, both Bank of Ireland and Irish Life & Permanent are due to update the market, and it is likely that this will maintain the momentum of positive sector newsflow.
Clearly, at some point in the future, the proportion of the construction sector in the overall economy will have to revert to more normal levels, but there is no reason to believe that this won't happen on a gradual basis.
In the meantime, Irish banking and insurance stocks should continue to deliver healthy profits to their shareholders on the back of strong growth in volumes.
Profit growth for the Irish financial stocks should therefore continue to be stronger than the European average for another one to two years. Yet the Irish banks do not trade at a premium valuation rating to their British and European peers. AIB and Bank of Ireland are currently trading on prospective price earnings (p/e) ratios of between 10.5 and 11.0.
In Britain, Barclays trades on a p/e of 11.6 and Lloyds TSB on a p/e of 12.0. An international bank such as HSBC is trading on an even higher p/e of 14.3. Of the British quoted banks, only Royal Bank of Scotland trades on a lower p/e than the Irish banks.
A similar picture emerges when comparisons are made with continental European banks. BNP Paribas and Danske Bank each trade on a p/e of over 15, while the Spanish bank BBVA now trades on a p/e of over 19. On the basis of these comparisons, Investor believes that the Irish financials offer exceptional investment value.
In addition, Irish dividend yields are comparable with payouts by British banks, and generally higher than those on offer in continental Europe. For example, Bank of Ireland's historic dividend yield is 3.4 per cent, compared with 3.6 per cent for Barclays and 3.3 per cent for Royal Bank of Scotland. Dividend yields in Europe are lower across the board - with, for example, BBVA paying a yield of 2.4 per cent.
With good medium-term growth prospects and undemanding valuations, the Irish financials stand out as offering an attractive home for investment funds.
