European equities: Beyond the GRANOLA stocks surge

European equities are having a bit of a moment. The Stoxx Europe 600 Index closed at a record high just before the start of the long Easter weekend, finishing its second-straight quarter of gains*. Powering the index of late has been the so-called GRANOLAS. These stocks are favoured by fund managers, but some are wary of over concentration, and say the European market has broader appeal investors should look at too.

Dubbed the GRANOLAS by Goldman Sachs back in 2020 – GlaxoSmithKline, Roche, ASML, Nestle, Novartis, Novo Nordisk, L'Oreal, LVMH, AstraZeneca, SAP, and Sanofi – are among the largest and most valuable companies in Europe. They share attractive qualities; solid earnings growth; defensive and low volatility; high and stable margins; strong balance sheets; compounders with sustainable dividends. In the 12 months to the end of February, they made up half of the gains on the pan-European Stoxx 600**.

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Sam Morse and Marcel Stotzel, managers of the Fidelity European fund, say the GRANOLAS offer investors a variety of sector exposure “including to health care, technology, consumer staples and discretionary”, and revenues diversified across several countries: “only around 20% of their revenues comes from Europe, with around 40% from the US and around 40% from the rest of the world”.

GRANOLA or Magnificent Seven?

Comparisons have been made between the GRANOLAS and the so-called ‘Magnificent Seven’ - US stocks that have been driving stock market gains in that country, though they would add that GRANOLAS trade at a significant discount to their US rivals, “primarily because investors are underweighting the GRANOLAS in global portfolios”.

The GRANOLAS have a lot to recommend them. Just like with the Magnificent Seven, however, the strength of the GRANOLAS has given rise to concerns investors are betting on too few stocks, and that returns are becoming over concentrated, and distorted. Zehrid Osmani, manager of the FTF Martin Currie European Unconstrained fund, says investors should be “looking under the hood” of the acronymed group of stocks.

“Performance dispersion of the GRANOLAS is wide. While ASML and several others delivered outsized gains, several pharma companies and Nestle underperformed the market in recent history,” he says.

Zehrid believes opportunities in European equities go much deeper. He points to European tech, for example, which has many leading companies in the semiconductor sector beyond ASML, such as BE Semiconductors (Besi), a leader in hybrid bonding.

These firms benefit from the trend towards onshoring, he says, as the US, Japan, and Europe reduce their dependence on Taiwanese semiconductor production – accounting for more than 90% – by subsidising plants to be built on their own soil. “An array of European companies in the semiconductor industry can allow an investor, in effect, to be exposed to the Apple ecosystem, without needing to hold Apple,” says Zehrid.

Beyond the ‘GRANOLA’ stocks

Elsewhere beyond the GRANOLAS, European stocks linked to discretionary spending have been doing well. Investors have been buying into European travel, retail and luxury goods companies***, in the hope the region’s economy is improving and consumers, feeling wealthier, will be enticed to spend.

James Hanford, manager of the Comgest Growth Europe ex UK fund, has owned some of the leading European brands exposed to discretionary spending, such as Hermès and Ferrari, for a long time. These are renowned brands which have existed for multiple decades. For reference, Hermès is nearly 200 years old. “Consequently there is a high demand for products of these brands,” James says.

He looks for companies that have performed well thanks to the longevity and durability of their brands. When evaluating discretionary spending companies for his portfolio a key consideration is how demand held up in difficult economic conditions, such as the global financial crisis.

“We do not want brands which have strong demand in upturns but then poor demand during downturns. We want brands which can deliver stable growth even in periods of economic weakness,” James says.

Investors in European companies could also benefit from looking further down the stock size table. Large caps, including the giant GRANOLAS, have led the European stock rally that began in October 2022, with a return of 36% to late March from the MSCI Europe ex-UK index****. This compares to 26% from the MSCI Europe ex-UK small-cap index****.

However, David Walton, manager of the IFSL Marlborough European Special Situations fund (which sits on our Core Selection), says a closer inspection reveals a newer trend. “It’s interesting that in the latest leg of the rally from October last year to date, European small caps have closed the gap, with a return of 18%^ to late March, which puts them neck and neck with large caps,” he says.

This suggests, David says, “Europe’s market rally is broadening out from a number of popular large caps to small caps, where bargain valuations and the potential for takeover offers mean there are highly attractive opportunities”. High-calibre European small-cap companies are on significantly lower valuations than they were two years ago, he adds.

Has the shine come back on Europe?

European stocks more broadly are being viewed attractively around the world. In its March European Equity Strategy update, Bank of America – having interviewed 50 fund managers in the US, Canada and the Nordics – said there was “notable interest” in Europe as a diversification play among those expecting the macro cycle to hold up, “given that European equities have lagged the global rally, offer attractive valuations and might offer a good way to position for an upturn in China” (with the Asian giant a big purchaser of Europe’s luxury goods)^^.

Spread across five sectors, the GRANOLAS offer investors valuable diversification. But just buying the group, or the Stoxx Europe 600 Index of which they now make up the biggest majority, may not be the best move given the variety of performance on offer, and the potential volatility of factors like consumer spending. GRANOLA member L’Oreal, for example, missed analyst expectations when it announced its underwhelming fourth quarter results in February and its share price dropped 7.6%^^^.

Investors seeking to ride the current wave of European stock market performance could be better off cherry picking from the GRANOLA stocks – or investing in a fund that does it for you – rather than buying them wholesale. At the same time it is worth considering some additional exposure to cheap-looking and well-performing European small caps, and digging around among the less well-known but solid names in the European tech sector too.

*Source: Reuters, March 2024
**Source: cnbc, 27 February 2024
***Source: Financial Times, 20 March 2024
****Source: Marlborough Fund Managers, data from 12 October 2022 to 20 March 2024
^Source: Marlborough Fund Managers, data from 27 October 2023 to 20 March 2024
^^Source: Bank of America, European Equity Strategy, March 2024
^^^Source: Reuters, 9 February 2024

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers and do not constitute financial advice.

Published on 15/04/2024