* Portugal’s PSI20 giving up gains, up just 3 pct for 2014
* BES shares down more than 50 pct in 3 weeks
* Earnings growth forecasts for Portuguese companies stall
* Valuations stretched versus rest of Europe
By Atul Prakash and Vikram Subhedar
LONDON, July 1 (Reuters) - Investors are becoming more cautious about Portuguese stocks as growing concern over Portugal’s biggest bank darkens the earnings outlook for the rest of the country’s companies, leaving valuations looking stretched and the market vulnerable to further selling.
Portugal’s PSI-20, one of Europe’s best-performing markets over the first quarter, has seen gains fade as analyst earnings downgrades mount and as worries around banks spreads to other sectors.
The index has slumped about 14 percent from a near three-year high in April, against a 2 percent gain recorded by the STOXX Europe 600 index.
The slide is led by Portugal’s largest listed bank, Banco Espirito Santo (BES). Half its market value was wiped out in the past three weeks, owing to financial troubles at its parent company and possible losses at its Angolan unit.
Both Portugal’s CMVM and London’s FCA market watchdogs imposed a short-selling ban on BES before markets opened on Tuesday. Short selling essentially bets a stock will lose value and, it can cause shares to fall faster.
Worries over BES has underscored the lingering issues around the health of peripheral Europe’s banks. It’s also hurting other Portuguese stocks, such as Portugal Telecom - which is indirectly exposed to Espirito Santo - and is pushing up Portuguese sovereign-bond yields.
“At some point, the problems at the banking sector will impact the pace of recovery in parts of the periphery. It’s a warning signal that we shouldn’t get overly positive about some of these peripheral markets,” said Peter Dixon, equity strategist at Commerzbank.
The earnings outlook for Portuguese companies is suffering as a result: Galp Energia, an energy firm, and retailer Jeronimo Martins have seen cuts to their EPS forecasts in recent weeks.
Today, Portugal has the weakest earnings-per-share growth projections among developed European markets.
The 12-month forward EPS for Portuguese companies in the STOXX Europe 600 index is down 4.2 percent in the past three months, against a surge of 23 percent for Greece and a drop of 1.8 percent for Spain.
“When you get earnings downgrades and negative investor sentiment, you would expect to see an impact on consumer confidence and the economy,” said Philippe Gijsels, head of research at BNP Paribas Fortis Global Markets in Brussels.
Gisjels said he prefers Spain and Italy and is advising clients to remain cautious on Portugal.
At 19 times forward earnings, Portuguese stocks are among the most expensive in Europe. The Stoxx 600 trades at 14 times earnings.
Portuguese stocks, key beneficiaries until last month of investor interest in peripheral European markets, have given up most of their gains for the year as it becomes clearer that earnings will fail to justify lofty valuations.
“There will be some weaknesses from time to time and there is a risk for investors in the banking sector,” Lorne Baring, managing director of B Capital Wealth Management, said. (Reporting by Atul Prakash; Editing by Larry King)