Analysis from David Walton (pictured), manager of the IFSL Marlborough European Special Situations fund
According to recent reports, locals in several of Europe’s most popular holiday destinations are fed up with mass tourism. Endless slews of visitors – Britons seemingly at their forefront – are no longer welcome.
This recalls a quote from Yogi Berra, baseball great and unwitting master of twisted logic. Asked for his thoughts on a fashionable restaurant, he reputedly declared: “Nobody goes there anymore – it’s too crowded.”
Whether fearful of a frosty reception or deterred by sheer numbers, many tourists may be tempted to take Berra’s warped advice and head off the beaten track. Often, of course, this is where Europe is at its best.
The good news for investors is that much the same can be said of European equity markets. Here, too, the most rewarding experiences are frequently to be found in areas that have long escaped many people’s notice.
The region’s smaller companies merit particular attention. Many have seen their share prices fall in the face of inflation, higher interest rates and slowing economic growth, yet in numerous instances this gives rise to attractive opportunities for investors with a long-term outlook.
Under-researched and underappreciated
It is first important to understand why the potential of Europe’s smaller companies is so widely unacknowledged. The simple answer is that these businesses are routinely under-researched.
On average, according to our own survey, more than 25 analysts are looking at each European mega-cap stock. By contrast, only four are looking at each small-cap. The figure for micro-caps is just one.
As a result, many investors – not to mention many fund managers – know little or nothing about the lower end of the market-cap spectrum. This gives an edge to investment teams that conduct their own research and are able to identify strong prospects that have yet to earn mainstream awareness.
Ultimately, the goal should be to find high-quality companies that benefit from good management, have a proven business model and demonstrate a capacity for growth. Crucially, they should also be undervalued.
Many of these hidden gems are in sectors that have been markedly out of favour during the past couple of years. This means their share prices may be significantly diminished – and the scope for recovery, in turn, may be notable.
World leaders hiding in plain sight
Industrial group VBG is a classic example of a high-performing European smaller company that has so far failed to register on many investors’ radar screens. Based in Sweden, it is nothing less than a world leader in its field.
The business is already the top producer of drawbars, which are the couplings used to link four-wheel trailers to trucks. It has also entered the air-conditioning market and is now supplying systems in the US, including as part of a huge programme to renovate ageing school buses.
VBG’s share price stood at around €12 at the end of December 2022. Twelve months later it had almost doubled, exceeding €21, and by June this year it had almost doubled again.
Italy’s B&C Speakers provides another illustration. A global supplier of many of the components used in high-end loudspeakers at live entertainment events, it faltered during the pandemic but has since rallied and positioned itself for further growth.
B&C’s share price slumped to around €7 amid the worst ravages of COVID-19. It climbed to more than €18 earlier this year and has stayed in the mid-to-high teens since. This underscores the importance of a long-term, buy-and-hold view in this arena.
Thriving in adversity
It is eminently possible that tourists rebuffed by Europe’s hotspots might conclude they should look considerably further afield or simply stay at home. Similarly, why should investors prefer European smaller companies over their US or even UK counterparts?
It is true that the equity culture in Europe as a whole is comparatively underdeveloped. European markets clearly trail those of the US and the UK in terms of their size in relation to GDP.
It is also true that there remain headwinds for these businesses. Perhaps foremost among them is the human tragedy still unfolding in Ukraine, with the conflict most obviously impacting companies with a more European-centric focus.
Sometimes, though, an investment case is more compelling in a challenging environment than in a relatively benign one. Much of the appeal of these stocks lies in the fact that they have continued to prosper – or at least to show genuine promise – in such difficult circumstances.
Yogi Berra also famously said: “It’s tough to make predictions – especially about the future.” He had a point, but I am confident in suggesting many of Europe’s smaller businesses will more than justify investors’ faith over the long term.
David Walton is manager of the IFSL Marlborough European Special Situations fund.
