Scrutinising Europe

While Europe is not without its well-publicised macro challenges, Sam Morse believes it isn’t all doom and gloom for investors in the region. He outlines why now is an opportune time to focus on sustainable dividend growers and discusses where he sees potential in the Fidelity European Fund and Fidelity European Values PLC.

Key points

  • We expect dividends to account for an increasing component of returns from European equity markets going forward.
  • Although Europe faces some key macro challenges, it is still possible to find attractively valued dividend-payers.
  • We see stock-specific opportunities in areas like pharma and financials that we believe are well placed to create shareholder value over the longer-term.

We are seeing a tougher macro environment for European investors this year compared to 2017 and 2018, with notable slowdowns in Italy and Germany in particular. There are also obvious political issues, which continue to weigh on sentiment towards continental European and UK equities.

Against this backdrop, we think that European companies are unlikely to see significant earnings or share price growth this year. Given this, it would be reasonable to expect dividends to account for an increasing component of equity market returns going forward. This should serve our strategy well. Both the Fidelity European Fund and Fidelity European Values PLC remain focused on identifying attractively valued and cash generative companies that we believe can consistently grow their dividends and outperform the broader market over a three to five-year view.

Encouragingly, we’re still finding quality companies with decent valuations. The EU is the largest economy in the world and although it’s not a region known for its innovation and extraordinary growth, it offers a diverse universe of solid companies that pay good dividends and can grow those over time. We believe such companies possess the strength and resilience to create shareholder value irrespective of the prevailing economic environment.

The portfolio today

In terms of how this translates into our current positioning, pharmaceuticals stocks comprise a large part of the portfolio. I am positive on Roche as the company is likely to continue to gain from its newly launched products and should be able to offset any negative impact from new biosimilar entrants. It also continues to benefit from the largest mid-to-late stage pipeline among European pharmaceuticals majors and this is starting to be better appreciated by the market. Novo-Nordisk is another key holding in the portfolio as its strong drugs pipeline and long-term growth prospects in the structurally growing insulin market bodes well for the stock.

Elsewhere, we also hold a number of sizeable positions in financials through Deutsche Boerse and 3i, although we are underweight exposure to interest-rate sensitive banks. The flat yield curve as a result of negative interest rates has meant that bank profits in Europe have been incredibly hard to realise and we have no exposure to the likes of such as BNP Paribas, Santander and Allianz. We also have big underweights to communication and utilities companies – they are cheap for a reason and very unprofitable.  

It is worth noting, however, that this positioning comes from bottom-up analysis of individual companies rather than any macro or sector bets. This is reflective of our intense scrutiny of company fundamentals and analysis of factors like free cash flow (a key indicator of dividend growth), balance sheet strength (dividend cover), management quality and, of course, valuations. 

Fortunately, we are still finding a number of opportunities that meet our quality criteria, but we believe adopting a relatively cautious stance today is likely to pay off over the longer-term.

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Important information

The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. The Fidelity European Fund and Fidelity European Values PLC can use financial derivative instruments for investment purposes, which may expose them to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Changes in currency exchange rates may affect the value of investments in overseas markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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