Investment Strategy: The Case for European Stocks
Don Fitzgerald, CFA, manages the Tocqueville Value Europe fund, based in Paris. The fund holds 80 million euros and serves retail and institutional investors. Mr. Fitzgerald typically invests in 50 to 65 positions, which include stocks in companies with varying capitalization. Stock selection is bottom-up and based on in-house proprietary research. Fitzgerald graduated from Trinity College Dublin in 1996 with degrees in business and German. He previously worked in structured finance for Citigroup and was an investor in distressed debt for WestLB in Paris.
CFA Institute: Why should individual investors now look to European stocks?
Don Fitzgerald, CFA: European stocks have disappointed since 2000, because at that point valuations were extremely high and stocks were extremely fashionable. Now, valuations in Europe are much more favorable because stocks here have fallen from grace, given all the bad press around the eurozone.
If you can live with the volatility, I believe European stocks can offer reasonable returns and dividends. The alternatives don’t look so good. Government bonds offer scant yields. Deposit rates for banks are next to zero. Gold is highly speculative and doesn’t produce any cash flow.
I think this makes European stocks an interesting space for an investor with a reasonably long time horizon.
You describe yourself as a value investor. Are you using the standard definition, or have you developed it further?
A. Value investing can mean different things to different people. It is about buying something for less than its intrinsic value. The idea is that the margin of safety protects the investor from the downside to some extent. This is a basic, common-sense approach to investing.
Some people try to put my investing style into a growth box or a value box. I’m a value investor, but I don’t just buy stocks that are statistically cheap. I analyze the business, the industry, the barriers to entry, whether the business has a competitive advantage, whether managers are good operators and if they can effectively allocate capital.
My take on value investing is that the approach should be nuanced.
So what gives you your edge, and what’s your favored way to value an investment?
I spent time working in distressed debt, where investing is all about cash flow, break-up values, identifying risks, minimizing downside, and buying with a comfortable margin of safety. These are all core value tools that have given me an edge in equity investing.
In the Tocqueville Value Europe fund, we put strong emphasis on figuring out normalized earnings power and analyzing returns stability, free cash flow generation, and balance sheet strength to get to our estimate of intrinsic value. Also, we often use sum-of-the-parts valuations for groups with multiple businesses.
Which regions are interesting in Europe now, and why?
We’re focused on western Europe. We don’t have much in the Nordic countries right now because stocks there are a tad on the expensive side. These countries have good economies, excellent well-managed businesses, and top-class corporate governance, but it’s comparatively harder to identify value opportunities. We don’t have many holdings in southern Europe either. Currently we have nothing in Spain, Portugal, or Greece.
Did that change over time?
It’s not really related to the euro crisis or the financial crisis. It’s more that we like to invest in good companies, and you tend to find fewer of them in southern Europe than in northern Europe. The companies in southern Europe that are good are bid up to a high price.
The main exception I see is Italy. Italy has some very good businesses that are not very expensive. They’re mostly industrial companies.
For instance, we own a position in Ansaldo STS. It’s a leader in signal equipment for the railway industry. It’s an industry with some technological barriers and some regulatory barriers as well. It’s a well-managed business with 9&% EBIT margins but with very little capital invested in the business. One reason it is probably a bit cheap now is that Ansaldo’s business is linked to state budgets. As governments restrain spending on infrastructure, businesses in this area are expected to slow down over the next years.
How do you identify companies to invest in?
We do quantitative screening to look for cheap companies, without consideration of benchmark, sector, or country allocation. With experience, you build up a list of companies you know and understand. I have a sheet I print out every week. It’s a sheet with several hundred companies, and I look at what has fallen in price and what looks particularly cheap.
Another approach is to target the shares of companies in special situations; for instance, when a company is spun off from a group. This spin-off can lead to shareholders selling off without analyzing the business. I see it as a hunting ground for possible mispricing.
I also attend conferences, meet management, and read the press. We work for relatively low portfolio turnover and avoid overconcentration in a single position. We also hold cash or equivalents when the pickings are slim.
In what way have you factored into your valuations the macroeconomic and political risk present in the eurozone right now?
At the moment, I’m not invested in many financial companies. They’re obviously the sector most affected. It’s hard to analyze from the outside and really come up with an intrinsic value for those businesses, so I tend to shy away. I’m invested in consumer-facing businesses and companies that provide goods and services to ordinary people in Europe.
I think Europe will have a low-growth environment for the next few years. Structurally, I expect higher growth in northern Europe than in southern Europe, and I keep this in mind, broadly speaking, when I look at a company.
But I don’t structure the portfolio to take advantage of this. One thing to mention is that many businesses in Europe are active globally. I don’t lose sleep over the eurozone crisis because I know the businesses I’m invested in will be there in 10 years. These are companies with good balance sheets that aren’t overly dependent on the capital markets.
Risk lurks everywhere. China is likely to slow down. And there could be a slowdown in the United States in 2013, depending on what happens with the fiscal tightening.
Europe gets a lot of bad press right now because there’s a restrictive fiscal environment. That environment will develop in the United States as well. It’s like Europe is taking the pain up front.
What do you mean by “Europe is taking the pain up front”?
I wouldn’t be too negative about Europe. I think a lot of the issues result from Europe dealing with its problems now — by restructuring the weaker economies and getting state budgets on a sustainable level — rather than deferring them. Second, as I mentioned, European companies aren’t entirely dependent on European consumers because many companies are global.
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— Interview by Rhea Wessel, a financial journalist in Frankfurt.
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