A hallmark of the past decade has been the chronic underperformance of value investing, the approach that focuses on stocks that are cheap in terms of price/earnings (p/e), price-to-book (p/b) ratios or dividend yields. It has lagged its rival strategy, growth investing, which involves seeking out high-flying companies that concentrate on getting bigger and rarely pay much of an income; they also tend to be expensive.
The gulf in performance between the two styles can’t last forever, but identifying a turning point is notoriously difficult. There are, however, early signs that attitudes are shifting. Things began to change last September when some investors started betting on economic recovery by ditching “growth” and buying unloved, and relatively cheap, businesses whose fortunes are often tied to economic cycles to capture an upswing.
The shift makes sense: central banks are cutting borrowing costs; credit is expanding; the China-US trade war has thawed; and governments are under pressure to help recovery via fiscal stimulus – opening up state coffers and spending their way out of trouble.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Whether the uptick in the global economy proves sustainable remains to be seen; but in any case, the past few months are a reminder for investors to focus on balance and diversification.
The UK and Europe both underperformed the US last year and offer cheap opportunities, while some other markets look overvalued compared with their likely future earnings growth. We look below at a diverse range of pan-European companies we think could reward patient investors. It is important to focus on catalysts that can unlock value, so growth prospects, corporate turnarounds, fresh management and new markets are key themes throughout.
Leisure and travel (LSE: CCL)
Cruise operators can be vulnerable to what economists call “external shocks”. Last year Carnival, the world’s biggest player, suffered several. It had to dampen investors’ expectations as tensions in the Gulf, a rising oil price and an American ban on trips to Cuba, a popular cruising destination, took their toll. Nevertheless, the last announcement of the year saw improved performance and is a reminder that setbacks can represent an opportunity for long-term investors focused on fundamental positives for the industry.
In 2018 there were 28 million cruise passengers but this still constituted a fraction of the multi-trillion dollar travel market. There are many more passengers to attract as people increasingly want to travel, so the future is promising. While one in two cruise-goers are American, only 3% of the country’s population have so far taken a cruise. Market share in Europe is also relatively low while the Far East also offers solid demand.
At the same time, the demographics bode well. Older travellers are a mainstay but millennials, the cohort born between 1981 and 1996, have an increasing appetite for travel experiences such as cruises. Cruise activity programmes and itineraries are well-placed to deliver this, and operators now recognise this group as their most important opportunity. Since the financial crisis, Carnival – which operates ten brands, including Princess, Cunard and P&O, and carries about half the global industry’s passengers – has delivered annual compound profit and dividend growth of 7.5% and 12% respectively. The shares, however, have gained just 6% a year and are undervalued, failing to reflect favourable long-term dynamics.
Fresenius Medical Care
Healthcare (Frankfurt: FME)
Based in Germany, Fresenius is a globally-diversified business focused on helping people with chronic kidney failure: treatment through dialysis is crucial for cleaning the blood. The group has over 4,000 clinics looking after more than 340,000 patients. The fact that it employs around 120,000 staff gives an idea of the scale of the operation. It continuously seeks to make its products more technologically sophisticated in order to maintain its strong market position and profit growth.
There is ample scope for further growth. The number of patients requiring dialysis is set to hit almost five million by 2025. The group is therefore expected to continue expanding both sales and profits steadily, yet it still trades on a p/e multiple of just under ten. This high-quality and innovative company offers investors global exposure to a growing medical need for a bargain price. That’s a formula for a healthy long-term return.
Groupe Bruxelles Lambert
Investment companies (Brussels: GBLB)
This €20bn holding company offers investors the chance to gain access to a portfolio of leading European names – a bit like buying into an investment trust. While some of its investments, such as sportswear group Adidas, might be considered growth stocks, the list also includes industrials and energy firms, as well as fashion, beverage and food groups. Perhaps the company’s most important attribute is that the shares trade at a 25% discount to net asset value (NAV).
The holding company has existed for decades and focuses on long-term value-enhancement. It aims to balance capital growth with dividend income and is currently yielding around 4%. Income seekers should note that the dividend has grown at 5% a year for the last 15 years.
Groupe Bruxelles Lambert has a conservative approach but it has consistently outpaced its benchmark and therefore offers a cheap means of gaining exposure to a range of pan-European enterprises that are delivering better-than-average returns.
Legal & General Group
Insurance (LSE: LGEN)
A low p/e multiple and a high yield can suggest “value”, but they can also be warnings that investors have given up and no longer believe the expected profits will be made or that the high dividend will in fact be paid. On the face of it, insurance and fund management group Legal & General falls into this category. It is an £18bn business on a p/e of under ten, yielding over 6%.
And yet not only is it profitable but both earnings and dividends are expected to keep growing over the coming years. Clearly, a business involved in finance and investment will be affected by Brexit uncertainty and general economic jitters; nevertheless, there seems to be good progress in its pensions business as well as in asset management. CEO Nigel Wilson talks of “immense” opportunities ahead. The company seems to manage its balance sheet well. Legal & General is growing but this isn’t reflected in the share price. It is a classic example of value and offers an excellent yield for income seekers.
Transport (LSE: NEX)
Travellers and commuters are switching to National Express. High rail fares, messy and protracted engineering works, and strike action are boosting the nationwide coach carrier with its cut-price offering. Records are being broken, with £577m of sales and 21 million passengers in 2018, and there was no let-up in the trend in 2019. Growth should endure over the next few years as the group grows its geographic coverage and adds more trips.
But Britain accounts for only a quarter of its sales. The rest are made abroad, mainly in the US, followed by Spain. Next time you’re watching television and see one of those yellow school buses, it could well be National Express.
It’s now number two in America with a transit and corporate-employee shuttle business serving the likes of Google, Nike, Boeing and Microsoft that has been growing by 50% a year. There is multi-billion dollar sales potential on offer here compared with today’s $600m, with university and hospital contracts being chased too. Successful pursuit of viable opportunities, savvy contract negotiation and keen pricing helped group profits rise 14% in the first half of 2019, and the dividend was hiked by 10%. Recent trading has been better than expected, and forecasts suggest another year of double-digit growth.
Strict financial discipline is a hallmark of a management team that knows its industry and can extend the current performance. Longer-term, environmental policies increasingly favouring mass transport over cars in ever-growing urban areas are positive. The stock’s discount to the market looks unwarranted.
Consumer goods (LSE: RB)
From Dettol to Cillit Bang and Nurofen to Lemsip, consumer goods giant Reckitt Benckiser (RB) has everything to keep homes sparkling, and coughs and splutters at bay. If only it were as effective at smartening up its own financial results and restoring some zing to its sickly share price.
Despite its strong international brands, RB has repeatedly missed investor expectations over the past three years, leaving its shares down 10% while rivals such as Procter & Gamble and Unilever have soared by 40% and more.
This is a comedown for a business that not so long ago was a highly-regarded manager of brands and products with a strong focus on shareholder returns. Turning things round is down to new CEO Laxman Narasimhan, a former McKinsey and PepsiCo executive who has spent months learning the business and is due to announce his plan in February with the annual results.
Key is restoring growth to the health division, which should offer better prospects than household products but is underperforming badly. This means investing and innovating. That will hold back profits near term but if it pays off, the shares should catch up with rivals. Success here could pave the way for a disposal of the household division to focus further on health. Change will take time but, for those with patience, analysts at Barclays see a potential 50%-60% gain for the shares, which yield nearly 3%, over the next three years.
Pharmaceuticals (Zurich: ROG)
Although not cheap on a p/e basis, Swiss pharmaceutical giant Roche does offer value for long-term investors. The group is popular because it delivers dependable results and has a stand-out record of increasing its dividends and generating cash that supports further research and development and thus the product pipeline.
Indeed, Roche is considered to have one of the strongest new development pipelines in the sector. It has secured many regulatory approvals for new treatments, augmenting its track record for offering life-changing therapies.
It derives much of its revenue from oncology (dealing with cancer and tumours). This is a strong sales generator but less of a growth area as products lose patent protection. On the other hand, there are expected to be gains in ophthalmology (eyes), neurosciences (nervous system, centring around multiple sclerosis and Alzheimer’s disease) and in-vitro diagnostics (blood or tissue-sample testing).
Neuroscience could be the path to some significant breakthroughs and new blockbuster drugs. Roche is a quality business with long-term research fitting well with the investment timescales of committed and patient investors.
Royal Dutch Shell
Oil and gas (LSE: RDSB)
Shell is undeniably focused on its shareholders. As Bloomberg put it last June, Shell “plans to shower its investors in money” after it announced it would return $125bn between 2021 and 2025, easily more than twice the level a decade ago.
This is big money given Shell itself is valued at £182bn. It anticipates significant cashflows from new projects as it operates in a more dynamic market increasingly influenced by the drive to reduce greenhouse gas emissions. Alongside conventional oil, gas and shale, lower-carbon electricity and power generation are key to sustaining Shell as a dominant player and generating the cashflows to maintain shareholder support.
Admittedly, total returns from Shell have at best been average over the last five or ten years. But the shares have hardly moved in ten years and now the stock is going to be paying out more than double what it did a decade ago.
Analysts see the shares gaining 15%-20% this year before the investor payouts are ramped up. There are question marks about the longer-term sustainability of Shell’s payout plans as well as heightened public scrutiny of the industry. However, the current yield of 6.2% and the p/e ratio of 13 alone make it of interest to investors seeking value and solid returns.
Tate & Lyle
Food producer (LSE: TATE)
Tate & Lyle’s sugar has been a household staple for years. Except, mirroring these health-conscious times, it went sugar-free nearly a decade ago. Nowadays this £3.5bn group helps manufacturers reduce their sugar content and makes artificial sweeteners, including Splenda.
It’s in the former activity that the money lies. Sweeteners are a decent business but growth will stem largely from manufacturers using its food and beverage solutions to cut calories as well as add protein and fibre across their products. Dairy Milk chocolate bars, for example, are being reformulated with a significantly lower sugar content thanks to Tate & Lyle.
On the face of it, this is exciting stuff – which manufacturers aren’t looking to achieve this as consumers turn ever more ingredient-aware? It’s a big theme and the group is in a good position. But it hasn’t converted this into consistent profit growth; the share price today is lower than it was three years ago.
Behind the scenes, there’s an efficiency programme led by CEO Nick Hampton. And the profits of the food and beverages solutions division recently jumped by 11%. One bank reckons this business will generate half the group’s profits by 2022, a 25% increase that would be good for the share price. The group also has scope to use its cash to buy its own shares and so boost returns. It’s cheap on a price/earnings ratio of 13 while the 4% yield is icing on the cake.
Media (LSE: WPP)
Global advertising conglomerate WPP is being re-fashioned to face rapid change. Technology giants such as Google and Facebook are offering direct online marketing and extensive consumer data, thereby disrupting and even eclipsing traditional advertising agencies.
Getting there will take time. We are one year into a three-year plan led by new boss Mark Read, who took over in 2018 after the sudden exit of Martin Sorrell, the group’s creator. Management is cautious and analysts are taking little on trust.
Recent results, however, were better than expected, giving investors some confidence that the strategy of re-focusing on core activities and streamlining operations is gaining traction. The shares jumped 6% on the news. At the current 1,000p they’re above their 800p lows but still well below early 2017 levels of almost 2,000p.
Of course while encouraging, one set of numbers hardly amounts to trend. This big task will have ups and downs. But with businesses being consolidated and others sold, debt falling and the expected drop-off in client sales slowing, management is standing by its guidance for future profitability.
If all goes well, investors could enjoy both rising profits boosting the share price and, in tandem, the shares being rerated upwards to trade on a higher multiple of those advancing earnings to reflect improving quality and dependability. Meanwhile, the big, market-beating 6% dividend yield gives considerable support.
Stephen Connolly is the managing director of consultancy Plain Money. He has worked in investment banking and asset management for over 30 years and writes on business and finance topics.
Trading terms: The Santa Rally
Glossary Will the Santa Rally result in its traditional December effect on global markets?
By Dr Matthew Partridge Published
Lock in high yields on savings, before they disappear
As interest rates peak, time to lock in high yields on your savings, while they are still available.
By Ruth Jackson-Kirby Published