As Europe begins to emerge from the grip of the pandemic, there is plenty of speculation about the shape of the recovery. Questions remain as to the speed of vaccine rollout, the revival of Covid-hit sectors and the long-term impact to the ways we work and live. Whilst consensus expectations are for 2021 to be a year of strong recovery, we remain more cautious. A lot of optimism is already being priced in, but risks remain. The Continent’s staggering debt levels, particularly in southern nation states, as well as the prospect of further disruption means we cannot rely on economic recovery to drive returns. Instead, we remain focussed on finding companies with strong balance sheets and sustainable dividend growth, that can deliver attractive growth even in uncertain environments,
Economic recovery is always a fragile process and particularly when it relies on defeating a capricious and unpredictable virus. Instead, we would rather build a portfolio that is agnostic on Europe’s financial fortunes and can perform well in all economic weather. We build a balanced portfolio across sectors, looking for companies that can also benefit from structural growth themes, such as digitisation, ecommerce or an ageing population.
In this, we have plenty of choice. Continental Europe is one of the world's leading economies and home to some of the strongest, most stable and resilient companies. There is a wealth of opportunities and many truly global businesses that draw their profits from across the world. This means we can select attractively valued companies that can deliver sustainable dividend growth – one of our key metrics - even if the outlook for the region is uncertain.
Four characteristics for growth
The breadth of companies in Continental Europe means it is important to be selective. As with all major economies there will be areas of sluggish growth and industries facing structural challenge or decline. Our priority is to zero in on those areas that can deliver long-term dividend growth, building a balanced ‘all-weather’ portfolio that can thrive in all market conditions.
To do this, we look for four key characteristics:
1. The first is that the business is in good shape: it operates in a market that has good long-term prospects, it spends its shareholders money wisely and it has a business model that has been shown to deliver results over time. We like businesses that generate strong cash flow, believing it is often a good indication of a company that can grow its dividends over the long-term.
2. We also like to see a strong balance sheet, which means lower debt. There are times when investors will overlook high debt levels, but 2020 showed the risks involved in high leverage. When revenues dried up, indebted companies were left burning cash. They were often the first to cut their dividends, as they didn’t have the resources to support payouts to shareholders. Dividend growth is our priority and this can be incompatible with too high debt.
3. We also want to see an attractive valuation. A good company can be a bad investment if it is too expensive, so we are careful on the price we pay.
4. Finally, positive ESG characteristics are an important input to our analysis. The focus on strong balance sheets, quality management and proven business models means that the companies we invest in typically screen well on ESG metrics.
Breadth of resource
Scouring Continental Europe for companies that fulfil these criteria is a team effort. While we only want to find 40-50 great companies for the portfolio, Europe is a vast and diverse market. We work closely with Fidelity’s skilled analyst team to undertake detailed stock analysis across all sectors. The 37 strong team European equity analysts cover hundreds of stocks, meaning we leave no stone unturned in our search for the best names for the portfolio. Through our research process we meet with company management and engage industry experts and independent research providers to build a holistic view of each company. For a stock to appear in the portfolio, we need three good reasons to buy – two fundamental, one valuation.
This is a philosophy that has served the trust well through all market conditions. We are hopeful of a recovery in 2021, but companies in our portfolio are not dependent on it materialising and should continue to grow even if it doesn’t. We focus on the elements we can control – finding good companies, with resilience and strong growth prospects, able to grow dividends over time. In this way, we can grow shareholder wealth over the longer-term, whatever the economic backdrop.
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