Published: May 12, 2010

Right now, these nations are the lowest of the low.

So low, they're referred to as the "PIIGS" (Portugal, Ireland, Italy, Greece, Spain). Their equity markets are among the worst-performing in the developed world this year.

But the good news is the downturn has opened up some opportunities for bargain hunting -- and these bargains come with high yields. Right now, these markets are offering some of the lowest valuations and highest yields in the developed world.

Spain's Ibex 35 index is trading at 11 times earnings and carries an average yield of 5%. Greek's benchmark ATHEX Composite Index sports a P/E of less than 10 and an average yield of about 3.5%, while Italy's FTSE MIB is trading at 13 times earnings and also yielding 3%. By comparison, the S&P 500 is priced at 17 times earnings and offers an average yield of less than 2%.

The Greek Problem
Of course, investors haven't shunned these markets without cause. All of the PIIGS suffer from high unemployment, an increasing number of non-performing bank loans, excessively high debt-to-GDP and budget deficits, and little or no growth expectations in the year ahead.

Greece is the weak link in the chain. Its unemployment and debt levels are not much worse than the other PIIGS, or than the United States for that matter, but it has the highest combination of both debt-to-GDP (115.1%) and budget deficit-to-GDP (13.6%) among these troubled countries. Exacerbating the problem, Greece bears the lowest credit rating in the Eurozone (the 16 countries using euro as their currency) and was just downgraded.

If Greece defaults on its debt, a domino effect heightens the credit risk throughout the region.

The Opportunity
A series of joint European Union/International Monetary Fund rescue plans are in the works, but uncertainty over how effective these rescue packages actually will be in staving off a regional credit crisis is keeping investors on edge. But when the bailout kicks in, and Greece manages to pay off an initial $11.2 billion 10-year bond that comes due on May 19th, European markets could get a further lift.

Now, as fears may have crescendoed, may be an opportune time to search for undervalued stocks that have been unduly tarnished by their association with PIIGS. The key is to find companies with strong earnings prospects in spite of -- or even because of -- the PIIGS' problems.

I've done a bit of digging and found plenty of opportunities in which income investors can take advantage.

Telecoms: Shares of Spain's telecom provider Telefonica (NYSE: TEF) are down about -20% this year and now yield close to 8.0%. The downward trend has tracked the country's benchmark IBEX 35 Index, which counts the telecom as its second-largest weighting.

But, in fact, the telecom derives 65% of its revenue outside of Spain, including 40% from Latin American countries that are unaffected by Europe's fiscal woes. A weakened euro has actually proven to be a boon to the company's cash flow.

Meanwhile, several other telecoms in the region also have worldwide operations in Latin America and other emerging markets that help insulate them from the troubles at home (and they trade on the NYSE).

Energy Plays: Many energy companies enjoy the same international revenue stream as telecom providers. In fact, Spain's biggest oil company, Repsol YPF (NYSE: REP) actually derives the bulk of its revenue from a wholly owned subsidiary -- an Argentine oil and gas producer.

While REP's yield is roughly 6.0% -- not as high as some European stocks I've uncovered -- it does represent a chance to pick up a solid company that's being unfairly lumped in with the rest of Spain.

Greek Shippers: It would be a mistake to dismiss certain quality stocks just because they come from troubled Greece. Greek-based shippers, in particular, are largely immune to their country's woes thanks to their international operations. Some have locked in steady cash flow from long-term contracts with credit-worthy firms from around the world.

Others, which operate in the volatile "spot" market (in which rates are determined in a daily basis) are more dependent on the global economic recovery. But whether they operate in the spot market or under long-term leases, their earnings are relatively unaffected by what's happening at home.

Banks: For a more speculative play, banks in the region could be worth a look.

Banco Santander (NYSE: STD), still carries a top notch "A" investment grade credit rating. Yet, as the largest component of Spain's IBEX 35 Index, the bank has tracked the index downward with abysmal year-to-date returns. Despite being Spain's largest bank, about 35% of profits come from Latin America, where it is also the largest bank by deposits.

Santander has paid dividends at an increasing rate since 1942 and now yields about 7.5%. The combination of reliable income and growth potential make Santander a compelling value play at today's prices.

Keep in mind that there's no guarantee the problems with the PIIGS are in the past. The road still could be rocky. But with a plan in place to help Greece and prevent the contagion from spreading, now may be a good time to start looking for ways to profit from a potential rebound.

-- Carla Pasternak
Editor
High-Yield Investing
High-Yield International