- European valuations are moderately cheap, pricing in macro headwinds and leaving potential to perform well
- Our investment process is highlighting lots of opportunities in good cash flow stocks across a variety of sectors
- We are upbeat on European equities as we head into a key period for the investment process
European valuations are not expensive
As we work our way through the full year 2024 results season, we are bullish on the outlook for European equities for a couple of key reasons. Firstly, market valuations are reasonable to moderately cheap. Secondly, we’re seeing encouraging signs in our analysis of corporate behaviour. We’re not observing much poor investment activity of the type which typically acts as a negative sign for stockmarket performance.
Of course, as results season progresses we’ll closely monitor all our investment screens for any significant changes. We’re also mindful of the negative headlines that have been associated with Europe for the last couple of years – be it weak growth or political instability in Germany or France. While uncertainty continues, European equity market valuations are not expensive and any positive developments could be a catalysts for these stocks to exceed depressed expectations.
An additional political uncertainty is around Trump’s tariff threats, which is generating short-term volatility. However, there are lots of European companies with some insulation through their international footprints – particularly those already with manufacturing operations in the US.
Good cash flow stocks across a variety of sectors continue to provide many attractive stock-picking opportunities
Looking at where the most attractive opportunities in Europe lie, we always fall back on the strict, disciplined application of the Cashflow Solution investment process, which strips out any emotional or behavioural investment biases. The first stage of the process is to rank the European universe by companies’ cash flow qualities in order to create a top 20% of Cashflow Champions – our watchlist from which we populate portfolios after further qualitative analysis.
The sector exposure of our portfolios is a direct result of us following the data in terms of where to find the most cash generative companies, both relative to their valuation and their asset base.
Over the last year, our investment process highlighted attractive opportunities in financial and consumer discretionary stocks and this led us to have an overweight position in these sectors.
In recent years, our investment screens have highlighted that the European banking sector is now in a very different position to where it was in the aftermath of the 2008 financial crisis, which ushered in a decade of underperformance. If we start with valuations, European bank shares are not expensive when you look at their levels of net income generation, and while we have seen a re-rating in recent years, some banks still trade at discounts to their book value. Turning to business fundamentals, banks are on average enjoying improving earnings growth and better balance sheet quality. Non-performing loans are generally quite low and they are increasingly generating higher surplus capital. This is positive from a shareholder perspective as it should feed through to higher cash return to shareholders.
UniCredit, the Italian bank, has been one of our larger bank positions in recent years. Under a new CEO it has enjoyed quite significant growth in the last couple of years and undergone a lot of restructuring. While there is speculation of a potential acquisition of Commerzbank, such a transaction would simply lead us to review the position. We monitor all of our positions on an ongoing basis, paying particular attention to balance sheet developments and cash flow statements.
While UniCredit is a good example of the strong earnings growth stories that can be found in the European banks space, there are also a number of companies which look attractive as self-help stories. Deutsche Bank, for example, was really out of favour for many years. A new CEO has spearheaded quite a lot of change to the management team and business restructuring in recent years. We bought into the stock in 2023 on a very low valuation and the stock has re-rated somewhat since then but is still trading discount to book value of over 30% It is gradually sorting out the legacy problems and is increasingly generating more excess capital – underpinning its recent announcement to target over two billion euros of shareholder distribution in 2025 through dividends and share buybacks.
Some consumer stocks have proven resilient to headwinds and could benefit from any uptick in Chinese demand
Looking now at the opportunity in the consumer discretionary area, we think some of the luxury goods retailers look good value. These companies have faced headwinds in the last 12 to 18 months in the form of Chinese slowdown and unfavourable currency trends. While a pickup in Chinese consumption could clearly be a boon to the sector, trading has actually been pretty resilient for some of these luxury names despite the mixed backdrop.
One of our favourites is Paris-listed Hermes. It has ranked as a recurring Cashflow Champion for several years due to its very high cash return on capital score, one of the key metrics we look at in our investment process.
We’re also attracted to the company because of its large family shareholding. We quite often find that companies with a large family shareholding have a really strong focus on cash generation in their business and a prudent approach to how they deploy that cash, which aligns well with what we look for with the Cashflow Solution investment process.
Because it’s a very cash generative business, it can self fund its own expansion by growing its store network and product range. It can also return a lot of cash to shareholders. At the moment it has a net cash position of about 12 billion euros.
Optimistic on European equities as we head into a key period for our investment process
Over the next several weeks we expect to see a large number of European companies issue annual reports covering the accounting period through to the end of calendar 2024.
This is a great opportunity for us to scrutinise their reports, looking for cash flow data and balance sheet changes, paying particular attention to any changes in accounting policies, revisions to prior year accounts and the stated forecasts for growth.
As we look to optimise our portfolios to incorporate this latest data and analysis, we are optimistic on the outlook for European equities and confident in the investment process’s ability to guide us towards some of the most attractive good cash flow stocks in Europe.
