Europe: Volatile share prices create opportunities for long-term investors

Mark Page and Laurent Millet, managers of the Artemis European Opportunities Fund, look at why, how and where fluctuations in European markets can generate opportunities for their fund.

When asked what the stock market would do next, John Pierpont Morgan is reported to have replied that “it will fluctuate”. His (apocryphal) answer proved accurate. Over the past 20 years, the European equity market has, on average, seen a 5 per cent ‘correction’ just over once a month (every 42 days to be precise). A 10 per cent sell-off, meanwhile, has come along roughly every six months (174 days). Such manic-depressive behaviour may be unsettling but can actually provide long-term investors with extremely valuable opportunities.

In part, our willingness to take advantage of these fluctuations has been one reason that the Artemis European Opportunities Fund has produced superior returns. In the four years since launch, it has generated a return of 56.4 per cent* in sterling terms, compared to 34 per cent for its benchmark, the FTSE World Europe ex UK index. (Meanwhile, the euro-hedged share class has returned 79.7 per cent since its launch).

We achieved this by ignoring the wider picture of political and economic forecasts and focusing instead on the total-return prospects for individual stocks over the long term. In the short run, a company’s share price will fluctuate with the market. Over time, however, it will track the return that the underlying business makes on its invested capital. That explains why we focus on superior franchises. Investors can be short-sighted at times, extrapolating from one disappointing quarterly report into the future. But rather than scaring us away, a falling share price can prompt us to invest – provided that the company has a strong balance sheet, favourable long-term prospects and good management.

A right price for everything

Our focus is on owning superior companies. But no business is good enough to be bought irrespective of price. Valuations are important. The importance we attach to them is illustrated by our approach to Edenred, a French issuer of prepaid cards and vouchers. There is huge long-term potential in this market and the depth of the company’s network of retailers and corporate customers in Europe and Brazil would be hard – not to say costly – for any challenger to replicate, particularly because most costs are fixed. It doesn’t need much capital to grow and, of course, it gets paid in advance for pre-paid cards, thereby generating a useful ‘float’. We bought a position in Edenred at the time of the fund’s launch. Its price-to-earnings (p/e) ratio subsequently rose from the low 20s (October 2011) to almost 30x by August 2014. At this point, we sold. Although it remained a good business, investors had become too optimistic about its growth prospects. Just over a year later, its valuation had fallen by 30 per cent. While the business had not changed, the market dumped the stock due to the recession in Brazil. At this point, we decided to buy back in. Trading at just 15x 2015 earnings and yielding more than 5 per cent, Edenred was just too cheap to ignore.

Making time our ally

Our aim is to find superior companies, buy their shares for a fair price and then hold them for the long term, selling only if they become too pricey or if fundamentals deteriorate. Time is the ally of a superior business. The higher the return that a business produces on the capital invested, the more compound value it creates for its shareholders. Swedish credit management company Intrum Justitia is a good example. The traditional credit management division (collecting overdue bills on behalf of clients for a fixed fee) is growing steadily and benefiting from the (slowly) increasing trend among European companies to outsource this business. But it also buys portfolios of debt from large companies and banks at a significant discount to the nominal receivable value – and collects the overdue bills for itself. This business is profitable and highly scalable. In the four years since we first bought Intrum Justitia, sales have increased by 9 per cent per annum, net income has grown by 23 per cent annually while its share count has actually decreased. The net result is that its earnings per share have increased by 25 per cent per annum – and its share price has more than doubled.

Stability amid fluctuation

So, after four successful years, how is the fund positioned today? Our process, which we developed and refined before joining Artemis, remains the same. The 53 stocks we currently own have been chosen on their own idiosyncratic merits, irrespective of country or sector. So while 25 per cent of the fund is invested in stocks quoted in Switzerland and 22 per cent in France, this is not because we are optimistic about economic growth in either country (we are agnostic). Instead, these weightings simply reflect where we find superior companies selling at attractive valuations. Our five largest active positions are the Swiss private markets specialist Partners Group, the Danish property and casualty insurer Topdanmark, the Swiss hearing aid company Sonova, the aforementioned Intrum Justitia and the French payment processing company Worldline. These are all financially solid, consistently profitable, disciplined, and attractively valued businesses. And because we have come to understand the economics of these companies we can make reasonably intelligent guesses about their futures.

As for the next four years? We suspect that the market will continue to fluctuate – and so create opportunities for long-term investors and their clients.

*Data from 28 October 2011. Source: Lipper Limited, class I accumulation units, bid to bid in sterling to 30 September 2015. All figures show total returns with net income reinvested.

THIS INFORMATION IS FOR PROFESSIONAL ADVISERS ONLY and should not be relied upon by retail investors.

The Artemis European Opportunities Fund may have a concentrated portfolio of investments. The fund may invest in the shares of small and medium sized companies. The fund may use derivatives to meet its investment objective, to protect the value of the fund, to reduce costs and with the aim of profiting from falling prices.