The case for quality stocks in Europe – Threadneedle’s Davis

High-quality European companies represent excellent value to long-term investors, according to Nick Davis, European equities fund manager at Threadneedle Investments.

The improvement in various European economic indicators is positive – whatever your investment style or even asset class. The size of the eurozone economy and the vulnerability of the global economy to further shocks should make us all grateful for Mr Draghi’s intervention last year.

Investor sentiment has undergone a startling transformation over the past 15 months, from the depths of despair before Draghi’s intervention to the current hopes for an economic recovery. Earlier this summer, I urged investors not to turn their backs on European equities. I am now calling on them not to ignore higher quality companies. In an uncertain world, challenges remain but we continue to argue that high-quality companies represent excellent value to long-term investors. While this remains our core conviction, we acknowledge that it is time to develop more balanced portfolios and to cast our nets wider in the search for exciting ideas.

The combination of an improving European economic outlook, relative valuations that were beginning to look stretched and emerging market concerns have created the perfect storm in which many high-quality global companies have underperformed their more domestically-oriented peers. The real question is what happens next – will the earnings recovery prove sufficient to justify the re-ratings we have seen? We meet many companies who talk of the stabilisation of the European economy rather than a recovery. Certainly, some domestic European share prices are discounting too much of a revival. Picking those businesses that will genuinely benefit from a rebound is a strategy that will reap rewards given that we have been through a phase when there was less differentiation in ratings.

Following the recent third quarter profit warning from Unilever, one analyst told me that this type of company is vulnerable because earnings were well above 2007 levels, while earnings in many other sectors were still below that benchmark. He saw this as a negative factor, but it is the exact reason why we own the stock. The ability to grow earnings year-in, year-out, drives strong, long-term performance. Companies whose earnings are not vulnerable to years of stagnation are exactly the type of businesses we favour.

 

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