Cheuvreux “letter” to Warren Buffett promotes European champions

Applying US investor Warren Buffett’s own theories of investing throws up seven key stocks that Crédit Agricole Cheuvreux believes the “Sage of Omaha” should consider adding to his own portfolio. Here are extracts of their “letter”.

Come to Europe and buy Sector Champions on the cheap!

Warren Buffett selects equity securities in the same way he would evaluate a business for acquisition…

His investment criteria comprise: 1) businesses that he can understand; 2) favourable long-term prospects; 3) businesses operated by honest and competent people; and 4) a very attractive price (from Warren Buffett’s Letter to Berkshire Shareholders, 1977). In his words, “A truly great business must have an enduring ‘moat’ that protects excellent returns on invested capital such as a company being the ‘low cost’ producer or possessing a powerful worldwide brand.”

…but he remains highly US oriented, neglecting several European champions

Mr Buffett’s success speaks for itself, but has been highly US oriented (the US represents around 94% of Berkshire Hathaway assets vs. just 4% for Europe). Looking at the industries in which Mr Buffett has invested over time, we see quite a few European champions.

In this report, we look at a few European champions and gauge their attractiveness on a stand-alone basis and compared to US peers

We have focused on five industries: three that have typically been preferred by Mr Buffett (Insurance, Apparel Retailing, and Food/Household/Personal Care) and two that seem particularly attractive in Europe (Capital Goods and Automotives). In insurance, we have selected Zurich and AXA; in apparel retailing, H&M; in household & personal care, Unilever; in capital goods, ABB; and in automotives, Volkswagen and Daimler.

Are European equities cheap enough for Mr Buffett?

European equities have recently bottomed out, reaching very attractive valuation levels. When we compare the European champions we have selected to deals made by Berkshire Hathaway in the US, we see that these European stocks offer higher growth potential and more attractive valuations.

A ‘Warren Buffett’ opportunity in Europe

Looking back over the past 40 years, Warren Buffett’s success speaks for itself: Berkshire Hathaway’s per share investment has been multiplied by 1,435 since 1970 (i.e. a compound annual increase of close to 20%).

Warren Buffett selects an equity investment in much the same way he would evaluate a business for acquisition in its entirety – he wants it to be: one that he can understand, with favourable long-term prospects, operated by honest and competent people, and available at a very attractive price (from Warren Buffett’s Letter to Berkshire Shareholders, 1977).

We also have sector champions in Europe…

Looking at investments made by Mr Buffett since 1977, we note that the vast majority have been in the US. Until 2003, he had virtually ignored Europe and Asia. Since then, he has gradually – but cautiously – invested in the latter two markets. At present, the breakdown of Berkshire Hathaway’s portfolio (i.e. consolidated entities and financial investments) is 94% US, 4% Europe and 2% Asia.

By sector, the group’s profile has also changed significantly over the past 20 years. We note three distinct trends:

   – A growing interest in the consumer goods sector over the past two decades (Coca-Cola, Procter & Gamble, Kraft, Fruit of the Loom).

   – A strong bias towards financials in the 1990s (both banks and insurance).

   – A growing interest in industrials during the past decade, notably since 2005 (Burlington Northern Santa Fe Railway, MidAmerican Energy, Lubrizol).

In this report, we have selected European champions based on the methodology put forth by Mr Buffett. We have gauged their attractiveness on a stand-alone basis and compared to their US peers.

We have focused on five industries that we have split into two categories:

   – Mr Buffett’s preferred sectors: insurance, food/personal care, apparel retail

These are Berkshire Hathaway’s historical sectors of interest, and we propose five European champions that we believe are very appealing on a stand-alone basis and compared to US peers. We have selected AXA and Zurich in insurance, H&M in the apparel sector, and Unilever in the food/household/personal care space.

    – Other sectors: auto and capital goods

Surprisingly, Mr Buffett has always avoided (partially or entirely) a few major sectors, such as the automotive and capital goods sectors. In our view, this may be because there are no US global leaders in these segments. Conversely, in Europe, some players in these sectors boast more attractive profiles. We have chosen Volkswagen and Daimler in the automotive sector and ABB in the capital goods segment.

…that are cheap enough to meet Mr Buffett’s criteria

We consider that the European market is currently attractive (on a stand-alone basis and vs. the US market) despite the uncertainty in the euro zone. P/E multiples in Europe are currently trading at a 28% discount to their historical average.

The decorrelation between the US and European stock markets has also been massive since the beginning of the 2000s. The US outperformance is particularly stronger since 2009 due to the euro zone crisis. We believe that we are at the dawn of a gradual catchup of the European market, which boasts many good-quality stocks at attractive prices.

We have compared our selection of seven stocks with their major US peers (whether held by Mr Buffett or not). We note that in the vast majority of cases, the European stocks we have selected offer better growth profiles and more attractive valuations.


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