Quality Businesses Make the Difference
However, identifying appealing industry dynamics isn’t enough for equity investors. To discover European companies with attractive long-term potential, we believe investors must look within structurally growing industries for high-quality businesses that can sustain consistent earnings growth over time. Select companies with the right attributes often offer investors higher, and equally important, more sustainable long-term growth rates than their broader industry groups. We believe these features augment the compounding power of holding these businesses for at least five years.
Businesses that have clear competitive advantages in industries with high barriers to entry are well positioned to maintain growth through good and bad times. Management skill and capital discipline are essential features for delivering growth through changing conditions. Strong fundamental metrics, such as return on equity and return on invested capital, point to business models with staying power and a good moat. Taken together, we believe these characteristics help bolster high cash flows that can fuel strong earnings growth over time—particularly within industries that have explicit structural growth drivers.
Semiconductors are a good example. Demand for increasingly sophisticated semiconductors comes from many directions, including the commercialization of AI, migration to the cloud and the massive growth of data centers. These trends are likely to persist through diverse macroeconomic conditions.
Manufacturing semiconductors requires highly specialized equipment, such as extreme ultraviolet lithography scanners, known as EUVs. Netherlands-based ASML, the only global manufacturer of EUVs, has developed the technology over 25 years with billions of dollars of research and development. Since EUVs have more than 100,000 parts, many of which are custom made, we believe the technology is hard for competitors to replicate, providing ASML with formidable competitive advantages in a market with multiple catalysts for growth.
Industrial Efficiencies: Unseen Sources of Tangible Growth
Industrial companies might not register on investors’ radars as high-growth businesses. Yet companies that help customers generate real efficiencies for their customers, through distinctive and innovative products, technologies or services command powerful sources of cash flows. These firms may not be household names, but their products often help machines, vehicles and buildings perform better and reduce costs.
Consider Spirax Sarco, a UK-based maker of steam-management products. The company offers more than 40,000 products used in an array of industries, from food production to pharmaceuticals, for critical manufacturing processes. Most of Spirax’s revenue comes from customers’ operating budgets, which are less vulnerable to cyclical swings in earnings than capital expenditure. Spirax’s direct sales model in key markets is differentiated from peers and integrates the company closely with its customers, in our view. Meanwhile, we believe the company’s steam and thermal solutions business is likely to enjoy structural demand from global efforts to decarbonize industrial processes.
Cut Through the European Cloud Cover
Quality companies in Europe might lack the star power of the US mega-caps. But that means investors can find European companies with impressive growth rates at relatively attractive valuations. In our view, buying durable growth at attractive share valuations adds to the compounding power of these businesses for equity investors with long time horizons. Select companies in Europe have generated highly competitive returns in a global perspective that transcend the regional market environment.
In investing as in life, stereotypes often lead to self-defeating biases. Europe’s broad equity markets may suffer from a regional malaise that has tainted investor sentiment and suppressed market returns, yet investors who cut through the cloud cover with clearly defined research objectives will find that select European companies with compelling long-term return potential are hidden in plain sight.
