From time to time, Morningstar publishes articles from third party contributors under our "Perspectives" banner. Here, Sam Morse from Fidelity outlines the case for investing in quality European companies. If you are interested in Morningstar featuring your content, please email submissions to UKEditorial@morningstar.com.
Article Summary
- Although bouncing back in recent months, European equities have lagged since the financial crisis
- The ongoing eurozone sovereign debt crisis has been a key concern
- However, in my fund, I’m looking to invest in companies rather than governments or individual economies
- Given the background of very low government bond yields, current historically elevated European equity yields look attractive
European equity performance has been held back by the well publicised sovereign debt worries of some eurozone countries. However, as an equity investor, I’m putting money into European companies not governments or economies. Once we look past the negative economic headlines, what we find is that there are actually quite a few excellent European companies out there that are doing a very good job for their shareholders.
European equities have been the laggards since the financial crisis. One only has to read the news headlines to understand that the weight of the region’s debt hangs heavily around its neck and the inability of its political leaders to get a grip on this debt crisis has compounded the problem. Investors, who have been concerned about a definitive solution to the eurozone’s problems, have tended to avoid European equities, preferring to look elsewhere.
Things have been rather better so far this year, with improving data and additional central bank ‘reflation’ activity, including the ECB’s liquidity operations, helping sentiment and boosting European equity performance. Risks remain however: corporate margins are high relative to history and may come under pressure again as European economies face more austerity. Although reduced since the recent Greek debt deal, the risk of a disorderly disintegration of the eurozone has not completely gone away. I continue to believe, however, that the eurozone will stay together, as the cost of exit would be too great both for those who leave and for those who stay. Austerity, and muddling through, is the lesser of two evils and will therefore remain the order of the day.
As an equity investor, I am putting money into European companies not governments or economies. European companies are not, of course, restricted to doing business in the countries in which they are listed. Many of the companies I own in my fund are large, multinational enterprises whose fortunes are actually rather more tied to the global economy rather than just the eurozone area.
European companies have, in fact, continued to grow their earnings and dividends, during this sovereign crisis, such that valuations ended last year at an historic extreme with an aggregate dividend yield approaching 5% which is a full 50% above the longer-term average for Europe over the last few decades. Although it has reduced in line with the better share price performance of late, the current yield available from European equities remains attractive when compared to the low government bond yields seen today in Germany and the UK.
This suggests to me, that much of the bad news is already priced into European markets. Dividends could be cut if economies falter and those high corporate margins come under pressure. They would, however, have to fall by almost a third for the current dividend yield on European equities to return to the long-term, multi-decade average. During the financial crisis, when many banks reduced dividends from generous levels to nothing, aggregate dividends fell by about a third cumulatively. This could happen again, of course, but I think it is unlikely, especially when you consider that many large banks are still paying very little in dividends so there is not much left to cut! Yes, there are risks to forecasts but, in my view, these are quite well discounted and so I believe there is fundamental value in European shares. As always, risk and reward are positively related and the biggest rewards often come when risk appears to be high.
From an investment point of view, the key question is: what to do now? Selecting cash-generative companies which have sound balance sheets, good business prospects and, therefore, the potential to deliver consistent dividend growth is a proven way to make money for investors. That a company is able to reward shareholders with a consistent and growing dividend is a sign of its good health and such companies are the bedrock of my investment philosophy. These sorts of companies may not sparkle in a sharp rally but they should deliver superior returns over a longer-term investment horizon.
Take Hugo Boss (BOS3), for example. This brand is well developed in European markets, particularly in its home market of Germany, but it has not been exploited to its full potential elsewhere. A management team, which was put in place a few years ago by majority owners Permira, are now rectifying this issue, having already done a good job in improving the basic operations of the company. All this is reflected in the excellent stock performance of late - in 2011, Hugo Boss profits increased by 54% to a record high EUR 291 million on the back of a 19% rise in sales, following significant growth in the US and China. The company also expects a solid 2012, with sales growth of up to 10% across all regions. Moreover, very much in line with what I had been expecting, the company has recently announced a significant increase in the dividend payable on its ordinary shares.
Another company I like is Schibsted (SCH). Traditionally a Norwegian newspaper firm, it has been successful in establishing itself as a leading on-line classified advertiser in Scandinavia, France and elsewhere. Many of these on-line sites are number one in their national market and this is a business where the winner takes all. Also, Schibsted is cash generative, has a strong balance sheet and is a high margin business with a favourable growth outlook. The valuation is reasonable, particularly compared to on-line peers, and investors receive a reasonable dividend yield that is growing at a very attractive rate.
Both Hugo Boss and Schibsted exemplify that there are ample opportunities for discerning European equity investors. The European economy is troubled because of sovereign debt worries but many companies are actually in good shape. It is important to remember that investing in European equities is not the same as investing in the European economy, or European governments. If we move away from the negative news headlines, we find that there are actually many good opportunities to be found across the continent. There are, of course, risks involved in investing in Europe, but, as noted before, risk and reward go hand-in-hand.
Sam Morse manages the Fidelity European Fund and the Fidelity European Values (FEV) investment trust. Both of these funds are rated Bronze by Morningstar, indicating Morningstar analysts believe the funds will outperform their peers and/or benchmark on a risk-adjusted basis.
Morse joined Fidelity in 1990 and spent seven years with the company as a research analyst, covering pan-European retail stocks, and then as a portfolio manager. He then left Fidelity to be Head of UK Equities at M&G. Sam returned to Fidelity in 2004 to manage UK equities for institutional clients. He managed the Fidelity MoneyBuilder Growth Fund from December 2006 for three years before becoming portfolio manager for Fidelity European Fund. He assumed responsibility of Fidelity European Values in January 2011. Sam has an MBA from INSEAD and a BA from the University of North Carolina.
This article was provided by Fidelity. The views contained herein are those of the author and not necessarily those of Morningstar.
