European equities have struggled to keep pace with their US counterparts for a few years. However, historically low European valuations mean we could be at an inflection point. But will market participants take notice? Or will capital remain highly concentrated in the US, where only a handful of stocks continue to lead?

What are the benefits?

By expanding its remit overseas DIGIT significantly increases its available opportunity set. We estimate that this widens the number of companies in our investment universe from around 300 to over 1000. It drives three main benefits firstly expanding the pool of higher yielding businesses allowing us to diversify our income exposure. Secondly it gives greater access to sectors to which the UK market has limited exposure such as technology. Finally it broadens access to a pool of great companies offering attractive total return potential. Our focus on continental Europe is driven by our investment experience but European stocks do have some welcome advantages. Typically revenues are more geographically diverse than those in the global market. Europe also offers broader sector exposure than many markets, such as the US where certain sectors disproportionately drive the market. While European companies have an increasing culture of paying and sustaining dividends to shareholders. That said, we are very focussed on specific European stocks rather than the whole market. The key is to invest in those businesses with the potential to deliver consistent, positive long-term total returns, particularly those with attractive dividend distribution policies. The opportunity to invest in a broader set of world-class companies shouldn’t be ignored.

Where do we see long-term opportunities?

There are prospects across Europe, but areas of strength include industrials, technology, healthcare, luxury goods, speciality chemicals and consumer staples. These sectors will be driven by big global themes, such as changing demographics, the energy transition and increased corporate investment in technology. Numerous European firms are also ideally placed to benefit from the burgeoning and increasingly affluent emerging-market consumer.

How does this look in practice?

ASML Holding develops, produces, and markets semiconductor manufacturing equipment. The company has a monopoly on the machines critical for making the advanced chips that will drive the current and future revolutions in computing, notably AI. We believe this edge gives it pricing power, high degrees of growth visibility and the ability to make attractive returns on capital. Management has framed 2024 as a transition year, which should translate into a successful 2025. Geopolitical tensions around China and related ‘chip wars’ are a concern. However, the company’s current strategy should mitigate against the worst-case scenario (a blanket ban). Importantly, its valuation suggests scope for meaningful outperformance due to expected growth and returns delivery. Turning to pharmaceuticals, we have Novo Nordisk. It’s a leader in diabetes care and offers insulin delivery systems and other diabetes products. The company successfully relaunched its high-profile obesity drug Wegovy to much fanfare. This could be an important source of future growth. Novo Nordisk’s deep scientific expertise and an industry with high barriers to entry mean it should maintain its strong market position. This standing also underpins the potential for double-digit revenue growth across the business.

One sector where Europe leads the world is luxury goods. And in this space, LVMH, which owns world-famous brands like Moet, Louis Vuitton and Dior, stands out. Following a strong 2021, there’s little evidence of a deterioration in its operating performance. Pricing power built on best-in-class brands and unshakable demand should provide insulation against cost inflation. The industry has proved relatively resilient in previous bouts of market upheaval. Increasingly wealthy emerging-market shoppers should also help drive sales in the coming years. Lastly, there’s Nordic banking giant Nordea. In our view, one of the most robust banks in Europe, if not the world. It has a reputation for prudence along with consistent delivery providing steady growth which has yielded a very attractive stream of dividends and capital returns to investors. Importantly giving us alternative exposure to what have been lacklustre returns from the UK domestic banks.

What factors are required for Europe to regain its appeal among investors?

Firstly, existing earnings expectations must underpin the cheap comparative valuations with other global equity markets. Secondly, European companies must deliver superior and sustainable earnings growth – a key factor in attracting investors. A third element is avoiding the political/economic challenges that have marred much of the past decade and consistently deterred international investors. Finally, a sustained period of stability characterised by cash returns and growth will be the best recipe to make European stocks attractive again in the eyes of investors. These factors, combined with a well-selected and focused portfolio, mean European equities can potentially compete with any in the world over the long term and we are very happy to include in DIGITs portfolio.

Companies are selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance. Past performance is not a guide to future results.

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