Looking for European equity bargains? Buy banks, Germany
* Euro STOXX 50 price/earnings ratio above 5-yr average
* Healthcare still looks cheap among defensives
* Financials attractive, especially vs book value
LONDON, Jan 23 (Reuters) - European equities no longer look cheap but there are pockets of value in some surprising places.
After gaining 33 percent in eight months, the Euro STOXX 50 index of euro zone blue chips is at its most expensive in nearly three years when prices are compared with how much firms are expected to earn over the next 12 months.
But the temptation to sell two of the region's biggest gainers - financials and German shares - could prove costly given they are still attractive on several measures of value.
"Cheap has quickly become less cheap. We suggest that investors are more selective on risk in the near term," said Jonathan Stubbs, European equity strategist at Citi, who favours the financial sector.
Bank stocks were hit hard during the financial crisis and again during the euro zone crisis because of their exposure to troubled sovereign debt.
They have rebounded but remain one of the cheapest sectors in Europe on a price/earnings basis and look especially cheap when shares are compared with the value of the assets on the company's books - the price/book ratio.
Concern about the quality and value of these assets was fanned by the big writedowns seen during the crisis. As a result, banks are trading nearly a third below the 10-year average of their price/book ratio, say strategists at HSBC.
They like the sector and also highlight tech hardware, energy, telecoms, media and healthcare as being undervalued in Europe even after the recent broad equity market rally.
Healthcare, which is traditionally seen as a defensive sector given people need medicines even in times of recession, is an attractive proposition for more cautious investors, according to some analysts.
"In healthcare you've got, in some cases, dividend yields approaching 6 percent, which are backed by free cash flow and supported by some earnings growth," said Raj Tanna, European equity strategist at JP Morgan Private Bank.
"It is the cheapest defensive sector out there. There are reasons for this discount, but there is also clearly an opportunity there."
By contrast, other defensive sectors, like consumer staples are already above their 10-year average when it comes to looking at the price/earnings ratio.
Tanna therefore recommends focusing on more attractively valued cyclicals such as industrials, which he expects to benefit as the global economy picks up.
Looking at national indices, Germany is still trading at a discount to the broader European market on a 12-month forward price/earnings basis, despite the DAX's near 30 percent gain in 2012 and its status as a 'safe haven' within the euro zone.
This "undemanding" valuation, coupled with prospects for earnings growth, has prompted HSBC to raise Germany to 'overweight' from 'neutral'.
Meanwhile, Spain and Italy no longer look cheap compared with their companies' recent earnings history, but are attractive on a price-to-book basis.
They might therefore appeal to investors who are willing to bet that the worst of the euro zone crisis is over and who are not overly concerned by Italy's national elections in February.
"Italy, in particular, for us is a very interesting market. There are some quality companies and clearly the multiples have been dragged down by political fears," said Ian Richards, head of equity strategy at Exane BNP Paribas.
Still, pre-crisis valuations won't be seen for a while, with the EuroSTOXX 50 trading on less than 11 times its expected earnings over the next 12 months - some way below the 13.3 times averaged over the past 20 years, according to Thomson Reuters DataStream.
"We don't think valuations are going to go up a lot from here, although they still provide an attractive platform if you are taking a three- to five-year view," said Peter Oppenheimer, chief European equity strategist at Goldman Sachs.