Europe: A compelling opportunity for long-term investors

Category: Asia, Global

Sponsored Statement

Despite a sharp rally in 2013, amid easing investor concerns and the region emerging from recession, Europe remains an attractively valued market on a number of measures, including price-to-book, earnings yield and dividend yield. There is also certainly potential for earnings recovery; having grown little over the past two years, corporate earnings are still far from their 2008 peaks, and many end-markets have room for significant improvement.

Value stocks looking attractive

For investors in ‘value’ stocks, the spread between the cheapest and most expensive quartiles of the market on a price-to-book basis is now at one of the widest levels it has been over the past 25 years. Moreover, during the previous occasions when the spreads have been as wide, the cheapest quartile was valued at around 1.9 times price-to-book. Currently it is trading on just 1.2 times, thus making ‘value’ stocks look cheap on both a relative and absolute basis. This potentially provides an attractive entry point as it is well documented that value investing has historically outperformed the market over the long term.

Positive environment for smaller companies

In the smaller companies universe, European smaller businesses are boasting some of the highest earnings yields in the world. We would argue that they are all the more attractive when compared against smaller companies in the US which are actually trading at a premium, with a lower earnings yield than their large-cap counterparts.

Smaller companies can offer investors dynamic growth opportunities, particularly when global industrial demand is rising. If we examine the correlation of small versus large companies performance and global industrial production, smaller companies have done relatively well in periods when production has picked up (see Figure 1).

Smaller companies have also profited from merger and acquisition (M&A) activity, with 98% of historic global M&A deals involving a small or mid-sized business.

Potential for rising dividends

Investors seeking income, on the other hand, should note that despite the economic headwinds, the environment for dividends in Europe is improving, and dividend yields on the continent now stand out among their global peers (see Figure 2). While a high yield is not necessarily an automatic signal of value, we are seeing increasing signs from companies and leading economic indicators that dividends have the potential to grow for the first time in years.

Why is this important? Dividends and share price performance tend to go hand in hand. A rising dividend puts upward pressure on the share price to perform and the combination of rising income and rising capital will tend to lead to an excellent total return over time as the power of long-term compounding takes effect.

With the outlook for European corporates brightening and the region’s equity markets offering attractive value, we believe that strategies seeking to take advantage of the ‘value’ phenomenon, invest in smaller companies or search for businesses that are able to consistently grow their dividends are well placed to deliver strong performance.

This advertorial is issued by M&G Investments and is intended to provide information about an investment strategy only. It is not an offer to enter into any transaction.