Three Reasons Not To Forsake Europe Just Yet

Three Reasons Not To Forsake Europe Just Yet
Theodora Lee Joseph, CFA

over 1 year ago5 mins

  • Investing in Europe doesn’t have to be a bet on its economy; the continent is home to many “quality” companies with global sales.

  • A strong dollar and lots of spare cash sitting on balance sheets are increasing the odds of acquisition sprees in Europe.

  • Europe may not be perfect – but it’s probably better than many investors think. What’s more, the risks will likely be tilted in its favor after this winter.

Investing in Europe doesn’t have to be a bet on its economy; the continent is home to many “quality” companies with global sales.

A strong dollar and lots of spare cash sitting on balance sheets are increasing the odds of acquisition sprees in Europe.

Europe may not be perfect – but it’s probably better than many investors think. What’s more, the risks will likely be tilted in its favor after this winter.

Mentioned in story

It’s hard to find reasons to be positive on markets now, and it’s that much harder to find reasons to be positive on European markets. Investors are practically lining up to bet against European companies, currencies, and bonds, as the continent contends with high inflation, a looming recession, and spiraling energy costs. But as value investor Howard Marks once said, you’ll need to think differently and better than others in order to outperform. So here are three reasons why you can still be excited about investing in Europe…

1: Europe is home to a ton of quality companies.

Investing in Europe doesn’t have to be a bet on its economy. Over half of the revenue that flows into its companies comes from beyond Europe’s borders, and the continent itself is home to many “quality”, or highly competitive, companies with global sales. Multinational luxury apparel, spirits, and car brands, with names like LVMH, Hermès, Kering, Richemont, Pernod Ricard, Ferrari, and Porsche, are all based in Europe and the recent market selloff could present a stellar opportunity to pick up their shares at a good price.

The world's most valuable luxury brands

While the luxury sector is not completely recession proof, its exposure to ultrahigh-income consumers puts it in good stead: faced with high inflation and energy costs, these heritage brands can increase prices without a material impact on demand from their affluent customer base. What’s more, since many of these companies still have the stabilizing presence of their founding families, they tend to take the long view and see past any present turbulence.

2: Its companies have longer-term incentives to cut costs.

European companies operating in the same industries as US companies have historically traded on a lower price-to-earnings (P/E) multiple. And they trade at that discount for good reason: on a like-for-like basis, European companies tend to have a more inflated cost structure than their US peers, due to higher tax rates, labor costs, and regulatory burdens.

Plus, while higher-priced energy is going to make things worse, it’s also the much-needed impetus for companies to focus on trimming costs to be globally competitive. After all, if ever there was an incentive to change, this would seem to be it. Energy costs are likely to peak this winter, and beyond that, you could see a slew of cost-cutting initiatives and fiscal policy changes that will benefit the economy when fuel prices normalize.

For companies that struggle with cost-cutting, there’s a different risk: acquisition. The weakened euro means their attractiveness as acquisition targets has increased, particularly in the eyes of US companies. A strong dollar and lots of spare cash sitting on balance sheets are increasing the odds of acquisition sprees. And companies that operate in fragmented industries, have a higher cost structure versus their peers, have non-replicable brand value, or operate in complementary geographies to competitors tend to be among the most interesting targets. For shareholders, this is potentially good news: acquirers typically pay a premium over the market price of the company.

3: Europe also boasts some of the leaders in green technologies.

Even as the world grapples with high inflation, a recession, and energy worries, it’s still also focused on the climate crisis. If anything, high gas prices and the pressing need for energy security will only hasten Europe’s transition to renewable energy, as evidenced by its REPowerEU plan.

Europe is a leader in green technologies and offers better investment opportunities than any other market. It’s home to leading wind turbine manufacturers like Vestas, Siemens Gamesa, and Nordex, as well as leaders in green energy production like Iberdrola, EDP, Enel, and Orsted. Rather than a one-off stimulus measure, many of the measures proposed by the European Green Deal will continue to drive growth over many years for companies exposed to the theme.

SG European Renewable index constituents

While there are lots of ETFs related to energy transition, many of them include global companies and won’t give you a clean exposure to discounted green European stocks. In addition to investing directly in companies exposed to these trends (mentioned above, or listed in the chart), you could also invest in the Invesco MSCI Europe ESG Climate Paris Aligned UCITS ETF (ticker: PAUE; expense ratio: 0.16%) or the Amundi MSCI Europe Climate Transition CTB UCITS ETF (LWCE, 0.18%) to gain exposure to European companies that benefit from the transition to a lower-carbon economy.

What’s the opportunity then?

With the Stoxx 600 down 21% this year and the euro down another 17% against the US dollar, Europe may not be perfect – but it’s probably better than many investors think. The “buy US, sell Europe” trade has been a popular one, but that also means that the sentiment is now “priced in” on those assets. The difference between the one-year forward P/E multiple of the S&P 500 and the Stoxx 600 is bigger than it’s ever been in its 15-year history.

US vs. Europe 1-yr forward P/E difference

Right now, it seems like the low point for Europe is likely to come this winter, but beyond that, the risks will probably tilt in its favor. A warmer-than-expected season, improving access to energy supplies, progress on intra-European sharing, or any alleviation of the Russian-Ukraine conflict are all positive areas of surprise that could move European markets.

Making money in the markets means staying ahead of the herd and sometimes being bold enough to stand against consensus. And that’s something you might consider doing now, picking up some quality European stock gems for the long-term at a nice discount.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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