European companies are now ripe for investment

Jenne Mannion looks at the plus side of going Continental with your investments

Continental Europe offers a plethora investment opportunities, but after three years of strong stock market performance, the easy money has already been made. Nonetheless, companies on the Continent are in robust shape and the economic recovery is well entrenched, offering scope for further decent returns.

Certainly, the European stock market has performed well over the past three years (until the end of August). The MSCI Europe (ex UK) index has gained 63 per cent, compared with the MSCI World Index return of 33.4 per cent.

There are several reasons behind this strong performance, not the least the fact the economy has recovered sharply over the past couple of years, driven by low interest rates. In particular, there are signs of a continued recovery in the French and German economies.

Meanwhile, companies on the Continent have been through a period of aggressive restructuring and are now in far healthier shape.

Gerard Lane, a strategist at Norwich Union, says: "European companies are in a position to pay dividends, reinvest money in the company or buy back shares - which has led to higher profit margins, better returns for investors, and higher share prices."

Cédric de Fonclare, manager of the Jupiter European Special Situations fund, says export-focused European companies are also benefiting from strong demand out of the US and Asia. He cites companies such as Schneider (a French electrical company), Tenaris in Italy (which makes pipes for the oil industry), and CapGemini (the French IT company).

And this buoyant export picture is, in turn, fuelling a healthier domestic outlook in terms of job creation and corporate spending. Hence Europe's consumers are waking from their slumber, with confidence across the Eurozone, reaching a five-year high in the July.

According to Roger Guy, manager of Gartmore's European Selected Opportunities fund, the surge in consumer confidence could lead to a wider economic recovery across Europe and provide further momentum for the stock market.

He says: "European consumers have the potential to boost the economic recovery and reinvigorate stock markets." Guy says such stocks to benefit from this trend include the likes of fashion retailer H&M and luxury goods groups Hermès and Christian Dior.

Leon Howard Spink, manager of the Schroder European Alpha fund, adds that strong merger and acquisition activity is also boosting confidence, with the financials sector the main focus following the merger of Italy's second and third largest banks, Banca Intesa and rival Sanpaolo IMI, in late August.

Yet there are still strong headwinds in Europe that cannot be ignored. Lane warns that if US growth slows more than currently expected, that will have an impact on companies based on the Continent. And the fact that the euro is strong compared with the dollar is disadvantageous to exporters. That has a negative impact on companies' profits, says Lane.

Paul Ilott, an adviser at Bates Investment Services, says that if European interest rates rise more than expected, consumers will feel the pinch. It must also be considered that following three years of good performance, European companies are no longer as cheaply valued relative to those in other developed markets.

De Fonclare says: "Many companies had reached all-time highs in terms of profits growth. It would be difficult for companies to substantially increase their growth from this base."

While these headwinds will mostly affect the larger companies, Tom Hooper, a pan-European investment manager at Aberdeen Asset Management, says certain smaller companies are ideally positioned to reap the long-term benefits of ongoing economic restructuring, as new labour laws and tax regimes across the region come into effect.

He says that as smaller companies are often overlooked and under-researched by professional investors, there are plenty of gems to be unearthed. Examples include Swiss chocolate and confectionery products maker Barry Callebaut, where a successful restructuring plan has been put in place. Another is Baron de Ley, a Spanish winemaker.

Helen Richardson, an independent financial adviser at Pantheon Investments in North Lincolnshire, says Europe is an important component of a diversified investment portfolio. She recommends that private investors hold up to 20 per cent of their portfolios in European funds.

Her preferred funds include Artemis European Growth and New Star European Growth. But she says there is also opportunity in emerging European countries such as Russia. Richardson says funds such as Jupiter Emerging European Opportunities provide exposure to these areas, though should only form a small proportion of your portfolio as they are higher risk.