- 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.
KEY RISKS
Past performance does not predict future returns. You may get back less than you originally invested.
We recommend this fund is held long term (minimum period of 5 years). We recommend that you hold this fund as part of a diversified portfolio of investments.
The Funds managed by the Cashflow Solution team:
- May hold overseas investments that may carry a higher currency risk. They are valued by reference to their local currency which may move up or down when compared to the currency of a Fund.
- May have a concentrated portfolio, i.e. hold a limited number of investments (35 or fewer) or have significant sector or factor exposures. If one of these investments or sectors / factors fall in value this can have a greater impact on the Fund's value than if it held a larger number of investments across a more diversified portfolio.
- May, under certain circumstances, invest in derivatives, but it is not intended that their use will materially affect volatility. Derivatives are used to protect against currencies, credit and interest rate moves or for investment purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions. The use of derivatives may create leverage or gearing resulting in potentially greater volatility or fluctuations in the net asset value of the Fund. A relatively small movement in the value of a derivative's underlying investment may have a larger impact, positive or negative, on the value of a fund than if the underlying investment was held instead. The use of derivative contracts may help us to control Fund volatility in both up and down markets by hedging against the general market.
- The use of derivative instruments that may result in higher cash levels. Cash may be deposited with several credit counterparties (e.g. international banks) or in short-dated bonds. A credit risk arises should one or more of these counterparties be unable to return the deposited cash.
- May encounter liquidity constraints from time to time. The spread between the price you buy and sell shares will reflect the less liquid nature of the underlying holdings.
- Outside of normal conditions, may hold higher levels of cash which may be deposited with several credit counterparties (e.g. International banks). A credit risk arises should one or more of these counterparties be unable to return the deposited cash.
- May target an absolute return. There is no guarantee that an absolute return will be generated over the time period stated in the fund objective or any other time period.
The risks detailed above are reflective of the full range of Funds managed by the Cashflow Solution team and not all of the risks listed are applicable to each individual Fund. For the risks associated with an individual Fund, please refer to its Key Investor Information Document (KIID)/PRIIP KID.
The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.
DISCLAIMER
This material is issued by Liontrust Investment Partners LLP (2 Savoy Court, London WC2R 0EZ), authorised and regulated in the UK by the Financial Conduct Authority (FRN 518552) to undertake regulated investment business.
It should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets.
This information and analysis is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content, no representation or warranty is given, whether express or implied, by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified.
This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID) and/or PRIIP/KID, which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.com or direct from Liontrust. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.
