Key insights
- Europe’s small and mid-sized stocks trade at cheap valuations relative to their history and other types of stocks
- The European Assets Trust (EAT) offers an easy way to buy high-quality companies from across Europe at a time of low valuations
- EAT’s portfolio manager is “cautiously optimistic” about the future
In Europe quality comes cheap. Evidently that does not mean the luxury Italian, French and Swiss fashion, watch and perfume brands. But there are other high-quality companies whose shares are trading at lower valuations than elsewhere.
After two years of higher interest rates, some companies from across the continent appear undervalued. Among them are leading companies from sectors like industrial, financial, consumer goods and technology.
It is widely recognised that Europe’s larger stocks are trading at lower valuations than their US peers. But small and mid-sized companies are cheaper still, both relative to their own history and their US equivalents. That makes the European Assets Trust (EAT) – which owns a portfolio of small and mid-sized quality growth businesses – a good way to access these under-valued opportunities.
For Mine Tezgul, EAT’s portfolio manager, the cloud of lower valuations brings a silver lining of opportunity. “Smaller companies recently has suffered from a tough backdrop,” she notes. “But this difficult environment means that there are even more opportunities than before. The sector has, unusually if you look at history, underperformed large capitalization companies and become cheaper in comparison.”
Smaller company stocks at low prices
Europe suffered worse from energy shock from the Ukraine war than the US. Seeking to quell inflation, the European Central Bank, alongside others, raised interest rates, knocking stock market valuations and especially those of smaller companies. At the same time, the promise of artificial intelligence in the US has sparked huge revaluations of big US tech stocks, meaning Europe has been overlooked.
Comparisons of index valuations vividly show how cheap Europe’s smaller companies have become, as these indexes give a broad picture. The MSCI Europe ex UK Small Cap Index trades on a forward price/earnings valuation ratio of 12.7,[1] far lower than the MSCI USA Small Cap Index’s 19.6. Iti is also lower than the MSCI Europe Index ratio of 13.6.
These measures are popular for judging the value of a stock because they compare its share price to the earnings that stock market analysts expect it to report for the coming year. As a stock market index is an average across many stocks, it provides an insight into the valuation of an entire regional stock market. We also look at other measures which are even more powerful and accurate representations of value – such as price to cash flow.
Low valuations make European smaller companies an exciting hunting ground. These diverse and poorly understood companies are ideal for stock pickers to deliver long term value. It is always important to sift the good from the bad, which is where EAT’s uncompromising quest for quality comes in.
“Our mindset is quality: we want business models that have the potential to generate and maintain high and sustainable returns,” explains Mine. “Put simply, we want companies that are exceptional because what they offer their customers inspires loyalty, and can enable better pricing and returns.”
Grounds for cautious optimism
As an example of how inexpensive some of EAT’s holdings are, Swedish online legal information provider Karnov received a takeover bid in May 2024 valuing it at 28% more than the prevailing price. However, Karnov’s shareholders rejected the bid on the grounds that even this price was too low.
EAT is able to find many high-quality companies like this. Earlier in 2024, we invested in Prysmian, a provider of cables to the growing offshore wind power industry. Prysmian is a leader in high-voltage direct current electric power transmission, where demand exceeds supply, resulting in pricing power and a strong order book.
As signs continue that inflation is under control in Europe while economies continue to grow, the combination of lower valuations and a reasonably stable macroeconomic backdrop should support a recovery in European stocks and smaller companies especially, according to Mine.
“European smaller companies have underperformed in the recent difficult backdrop and are now very cheap relative to history and to larger companies,” she notes. “Many investors have shunned the sector and are underweight. We are cautiously optimistic for the future and looking to exploit opportunities.”
[1] Source: MSCI. As at August 30, 2024.
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