Germany is the economic powerhouse of Europe and home to some of the continent’s most important companies. We discuss the pros and cons of investing in German stocks.
- Pros of Investing in German Stocks
- Risks of Investing German Stocks
According to the IMF, Germany is the fourth largest economy in the world, only behind the United States, China and Japan. Compared to its European neighbors, the German economy is substantially larger than the either the French or British, twice as large as the Italian, and three times as large as the Spanish.
When it comes to the number of people working in the country, according to CIA World Factbook, the German economy has about 44.5 million workers. For reference, the United Kingdom has about 35.5 million, France 28, Italy 23 and Spain 19.
And in terms of GDP per capita, a metric that can be used to measure average wealth and productivity in a country, Germany is substantially richer than the other four large European economies, as we can see in the table below:
At the same time, the German economy is well diversified, not only in terms of economic sectors, but geographically. While the UK and France are overly dependent on the economies of London and Paris, respectively, Germany has many important economic centers.
While Berlin is the political and administrative capital of the country, and home to many start-ups, Frankfurt is the financial center. Hamburg dominates the creative, press and media sectors. Düsseldorf and Cologne have manufacturing, telecommunications, energy and finance. And in the south of the country, Munich and Stuttgart are two of the world’s most important car manufacturing regions.
For all these reasons, it is not surprising that the German economy has some of the most famous companies in the world, active in several different sectors.
Within the automotive industry there are Daimler (Mercedes), BMW, Porsche, and the Volkswagen conglomerate which includes the Volkswagen brand, Audi, Seat, Skoda and Lamborghini. In the industrial and chemical sectors we have Siemens, Thyssen Krupp, BASF and Henkel.
Bayer and Fresenius are important players in the pharmaceutical sector. Allianz and Munich Re in insurance. And SAP, Germany’s largest company by market capitalization, is in the technology sector.
All these corporations are part of Germany’s most important stock market index, the DAX, made up of 40 of the country’s largest companies.
Pros of Investing in German Stocks
Let us discuss several reasons for investing in Germany:
One of the main advantages of investing in German stocks is that the German economy is one of the most stable on the continent. That makes their companies better able to withstand difficult macroeconomic conditions.
As we have already discussed in the introduction, the German economy is highly diversified from both a sectorial and geographical point of view.
Germany is also an exporting powerhouse. Germany sells all kinds of products, most of them with high added value, all over the world. The demand for German products from China, the United States, Japan and other European countries means that its economy is not overly exposed to any one market.
Apart from that, Germany has often been one of the most fiscally responsible countries in Europe. The state of the German public finances is much better than that of most developed countries in the world.
As a result, the country’s government has room to support the economy if difficulties arise, which helps keep the unemployment rate low and cushions the impact on businesses’ bottom lines.
Low Corporate Financing Costs
The German government is the institution with the lowest financing costs in the euro zone. This is due to its relatively healthy financial situation, the size of its economy and its status as the region’s hegemonic superpower.
In other words: investors estimate the probability of a German government default to be effectively 0. It is the same privilege that the US government has in US Dollars, or the government of Switzerland in Swiss Francs. No other country in the euro zone enjoys such a privilege by default.
This privilege enjoyed by the German government positively impacts the country’s corporations. Since corporate financing costs tend to be relative to the government’s, German companies are able to get cheaper financing than some of its French, Spanish or Italian peers.
By investing in German stocks, we can benefit from that privilege. Lower financing costs translate into a lower production costs and, hence, into a stronger market positions and wider margins.
Another positive aspect of investing in Germany is the importance of its industrial sector. As we have addressed before, Germany has leading companies in many different industries.
On the one hand, a strong industrial sector makes it more likely for Germany to benefit from economic growth in other countries. For example, if the Indian economy grows and its middle class broadens, the demand for German cars will likely increase.
On the other hand, the importance of the German industrial sector makes its own middle class stronger than in other countries. After all, the manufacturing sector usually pays better wages than the services sector, reflecting its higher productivity and value add.
According to CIA World Factbook, in 2017, 31% of German GDP was generated by its manufacturing sector. If we look at other large European countries, we will see significantly lower percentages: Italy (24%), Spain (23%), the United Kingdom (20%) and France (19.5%).
The electric vehicle is one of the megatrends of the global economy for the 2020s and 2030s. It represents an incredible opportunity for Germany, even though many investors might think that companies such as Tesla have a very big advantage over German car manufacturers.
However, German cars enjoy a sterling reputation all over the world. Whether it is Porsche, Mercedes, BMW, Audi or Volkswagen, consumers associate German cars with luxury and quality. And this will not change with electric vehicles.
By investing in German automobile stocks, we can profit from that trend. And, unlike Tesla, these companies tend to trade at much lower valuations, reflecting much lower expectations.
Finally, another one of the positive aspects of investing German stocks is their relative status as safe haven assets in times of serious economic, political or monetary crisis in the euro zone. Such status is obviously relative to other countries and not absolute, like gold.
For example, if there was ever a collapse in the euro and the monetary union were to disappear, German stocks would start trading in the new German currency. Just this fact alone would probably mean that their value and stability relative to companies from other euro zone countries would be much higher.
Risks of Investing German Stocks
Next, we discuss some of the disadvantages associated with investing in German equities:
Low Economic Growth
Because Germany is already a rich and developed country, its level of economic growth is low. This is mainly due to two reasons.
First, rich countries have less potential to grow than poor countries. Its infrastructure is already largely developed, its workforce trained, and its markets are quite efficient.
Second, rich countries tend to focus more on policies that improve the standard of living of the population today, at the expense of future economic growth and the future standard of living. This focus on the short term, while not as pronounced in Germany as in other Western countries, makes growth rates lower.
Another negative aspect of investing in shares of German companies is that the country’s demographics are worrying. Germany’s population is aging fast, and that will cause the number of retirees to increase in the future, at the same time that the size of the workforce shrinks.
While this does not pose risks to the country’s social security system, given Germany implemented major pension system reforms in the 1990s, the shrinking workforce is.
Fewer available workers mean fewer opportunities for future domestic growth and economic development, as well as a potential increase in labor costs that can damage the competitive position of many companies.
Lastly, one of the weaknesses of Germany’s economy is the country’s energy policy. For the last couple of decades, Germany had been moving away from nuclear energy and in the direction of relying more on natural gas and renewable energy sources.
The supply of natural gas is no longer guaranteed as most of it came from Russia. Geopolitics has impacted relations between the two countries in a way not seen since the middle of the previous century. Therefore, Germany will need to rely on importing LNG from overseas countries, such as the United States, Canada and Qatar.
At the same time, renewable energy has proven less reliable than anticipated. This has brought policy makers to reopen some old coal plants.
The main consequence of these policies for equity investors are potentially higher energy prices for the country’s manufacturing industry, damaging their competitiveness and commercial margins. This is something, however, that could be solved in the medium and long term.
As we have discussed, the German economy is not only important for Europe due to its size, but because it is one of the most stable and robust. Consequently, for anyone interested in investing in equities, German companies are to be considered.
There are many ways to invest in the German stock market. One option is to select those companies that we like best. The other is to invest in an ETFthat tracks one of Germany’s stock indices.
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And if you want to learn more about Germany, check out this link:
Taxes in Germany – A Complete Guide