“In the short-term markets are a voting machine, in the long-term a weighing machine
”, is one of our favorite quotes from Benjamin Graham.
For the time being, Mr. Market
is definitely in a depressive mood and there only remain a few trading days left for a potential year-end rally. While our children eat the chocolate they received for St Nicolas, investors have less pleasant news to digest from trade wars, inverting yield curves, Brexit to Italy. In Europe, it also looks like 2018 will go down in history as a very difficult experience for value investors, especially the ones investing in the small and midcap area like we do.
A simple comparison between the performances of the MSCI Europe Growth Large Cap against the MSCI Europe Value tells the whole story of 2018. Up to Wednesday’s close (05.12.2018), smaller value stocks underperformed their large growth peers by 9.17%, a level not seen since the year 2011.
Source: Bloomberg, data from 29/12/2017 to 05/12/2018. Past performance is no guarantee of future results.
However, I maintain my view that value will make a strong return once the dust settles.
So far, we have heard a lot about the bear case on European equities. However we need to remember that in the long-term there are only 2 things that matter for investment returns: valuations and earnings generated by the companies. And, here the investment case looks compelling for value investors in Europe.
First, European equity markets are inexpensive after a year of multiple contraction and political uncertainty.
As illustration, Eurozone stocks are currently trading 12.1 forward earnings, a level 7% below the 30 year median, 16% below the valuation at the beginning of the year and 24.4% below the US (source: JPMorgan, IBES). At the same time profits are still projected to grow at 8% this year.
Secondly, we believe that the market leadership of many current growth companies will increasingly be challenged.
While we certainly agree that they offer disruptive business models challenging the moats of the more established businesses, as value investors we believe it is next to impossible to accurately pick the winners that will be able to translate their innovative business proposition into actual profitability. If history is any guide (and I believe it is), the current stock market leaders, the growth stocks of today with disruptive business models, will probably not be the stock market darlings 10 years from now. During the TMT bubble in 2000, out of the 10 biggest market capitalizations in the world, 7 were technology companies. 18 years later, we still have 7 technology companies as the market leaders; but. only 1, namely Microsoft, succeeded to remain in the list of the most valuable companies worldwide. Investors in NTT Docomo, Cisco, Intel, NTT, Alcatel-Lucent and Nokia had a difficult time in the stock market (source: presentation of MAJ Invest at International Value Conference in Luxembourg on October 24th
My point here is that it is much more reasonable to focus on the earnings the company is actually currently generating and able to maintain in the future with a reasonable level of certainty than to focus on a potential (uncertain) future growth.
This is exactly what we try to do as value investors.
In our portfolio, we aim to invest in strong businesses with solid balance sheets and competitive positions generating strong cash flows. Valuations are currently at unseen levels: the median company in our portfolio trades at 39% to our estimated fair value compared to 21% just a year ago! We see ample investment opportunities and will put more money of our 9% cash position to work in the coming days.