Raj Tanna, European equity strategist and César Pérez, EMEA chief investment strategist at JP Morgan Private Bank have looked at the case for investing in European equities.
A very large part of the cost base of a company is labour, and with economies far from full capacity globally, we don’t expect significant wage inflation and an increase in labour costs. Companies also continue to cut costs and have seen impressive gains in productivity alongside this.
Both of these factors lead us to be optimistic on the sustainability of margins seeing only a case for mild contractions. The strong rebound in profitability has also led to an equally strong rebound in cashflow generation over recent years.
This is important for us as we consider cashflow to be the true profit of a company. During previous periods of economic recovery, companies used excess cashflow and took on additional debt to drive business expansion in anticipation of growing demand.
During this recovery, however, companies haven’t increased leverage with capital expenditure and acquisition activity remaining at all time lows. Instead, management teams are increasingly likely to pay cash back to shareholders via dividends or share buybacks.
Despite economic growth being anaemic in Europe, European companies have become increasingly global in nature and now generate a significant portion of their revenues from outside of the region.
So the relationship between weaker GDP growth in Europe and sales / profits growth is less direct than it has been in the past. European multinationals also have particularly large exposure to developing economies, which are expected to continue to grow at a much healthier rate than that of the European region. Many of these economies are also shifting from export led growth to domestic demand led growth.
On average, European companies pay a dividend of around 4%, which compares very favourably to that of deposit rates or even longer term government debt in Europe.