Are European equities cheap at present?

The valuation of the European market is relatively cheap when compared to last year (2018). I think that’s about as far as I’ll go when trying to value the overall level of the market, as it doesn’t really interest us.

So what does interest us? There are two things. Firstly, are we are finding more opportunities that we already own to add to, or more opportunities to trim positions that we already own? And the fact is, over the last six to 12 months we have increasingly been finding opportunities to add to existing holdings. So businesses that we know and like, we have found at more attractive levels. That is the first thing to look at when judging my own confidence on valuation.

The second thing I would look at is that we operate a watchlist approach. So we have the strategy, and then we have a watchlist – our ‘second team’ of investments, so to speak. So we analyse and we research and we cover these companies as if we own them. If the watchlist is growing, then that for us is a bullish signal. If it’s shrinking and we can’t find any businesses that we can put on the watchlist, then that is a bearish thing. At the moment, we find that we are adding investments onto that watchlist. So I would take that as a fairly balanced, slightly bullish outlook from here.

What are your views on UK equities, given current Brexit uncertainty?

We never really look at individual geographical regions and compare them to other geographical regions. Maybe, 20, 30 to 40 years ago, that mattered. But when we look at the markets today, the UK is not full of UK-listed domestic businesses. It is full of international companies, especially the FTSE 100. So we are not going to look at the UK and not want to buy it or buy it and reflect that in our views on how many UK businesses we own. What is far more important to us is not the area of listing, but the quality of the business and quality of the investment opportunity.

Looking at the UK at the moment, I can see a few companies that we already own that I see as being very attractive business models on a long-term view. Classic compounders in nature. I would highlight Prudential as one of those – a UK-listed but very much international insurance business. There are also some businesses in the UK market that I see as capable of improving their return profile over time. I would suggest BP as a good example and, in fact, Shell as well – two businesses that we own. So big oil companies where operational cost discipline and capital expenditure discipline has improved and the return profile over time should go with that.

Are there any areas of the market that you currently favour?

When I look at the sectors we invest in, there are some real biases that are inherent, given our investment process. The focus of the investment process is return on capital. That is the predominant thing we look at. And there are certain sectors where we find businesses that can consistently generate high levels of return on capital. So the ones I would highlight would be firstly healthcare; we have a very good exposure to pharmaceutical businesses and some healthcare services businesses. We see those as big companies with high barriers to entry, mainly based around scientific knowledge and research prowess.

IT is another area that we are heavily exposed to, and in particular software. This is an area where we have found businesses that have very attractive cash dynamics and high return on capital due to the low capital intensive nature of these businesses and their strong pricing power. To that we would add industrials, which is a bit of a ‘catch-all’ sector. It captures many different types of businesses. But again, within industrials, we have found some attractive businesses. Professional publishers are one example, and the airline Ryanair would be another – so two very different types of business model in that sector.

The flipside of that is that there are some sectors where we struggle to find attractive businesses. It is not because we don’t like the sector. It is because we cannot find the individual opportunities. So when I think about telecommunications, for example, we don’t find that area particularly attractive. They are highly regulated, price-taking businesses, exposed to rampant competition everywhere they look. Mining companies, we struggle to see any pricing power there. By nature, they dig up a commodity and sell it – not something we think is attached to strong pricing power over time. It is hugely skewed by demand and supply dynamics. So that’s two sectors that generally we would avoid.