Made in Europe

High profit margins, above-average growth, and a strong performance – this delightful triad is not reserved exclusively for the shareholders of the big US technology companies. A small group of stocks also on this side of the Atlantic shares those very same attributes. Moreover, they are more broadly diversified, less volatile, and better dividend payers than their counterparts from the USA. Are the GRANOLAS a better version of the Magnificent Seven?

 

(Overlooked) European Champions League

Europe, too, is highly skilled in deep tech, innovation, and cloud computing. Without equipment from ASML, Nvidia would be incapable of producing its graphics processing units that are currently in hot demand for artificial intelligence applications. Years of research by Novo Nordisk have brought forth Ozempic and Wegovy, two modern effective drugs against diabetes (and obesity). And with SAP, the old continent also boasts an IT giant that is capable of keeping up with the competition from Silicon Valley at least in some subdomains. All three of those names belong to a small group of companies that embody a combination of robust, high-quality growth and a correspondingly strong stock-price performance just like the Magnificent Seven (Mag 7 for short) in the USA do, though with the small but distinctive difference that the stocks in the European Champions League stand less in the spotlight than the Mag 7. Their relative obscurity may owe in part to the fact that the financial industry hasn’t yet come up with a better collective name for the European equity heavyweights than the acronym coined by Goldman Sachs, which has dubbed them the GRANOLAS (GSK, Roche, ASML, Nestlé, Novartis, Novo Nordisk, L’Oréal, LVMH, AstraZeneca, SAP, Sanofi). However, this group of eleven stocks is by no means as bland and boring as a bowl of Swiss Bircher muesli. Quite the contrary, in fact, their performance over the last three years bordered on spectacular. With a share-price advance of 65% (in euro terms), they were more or less at eye level with the Mag 7. This is not a contradiction in the face of the booming US economy of late versus Europe’s rather sluggish economic activity. It instead is much more a reminder that the world’s largest companies today operate internationally – exceptions confirm the rule.

 

Less volatility, same result | The GRANOLAS exhibit a better risk-adjusted performance

Performance comparison: GRANOLAS vs. Magnificent Seven, indexed (Jan. 1, 2021 = 100)

Sources: Bloomberg, Kaiser Partner Privatbank

 

Commonalities with the Magnificent Seven…

The absolute performance in recent years wasn’t the only similarity. A comparison of the GRANOLAS with the Mag 7 also reveals quite a few other things in common:

  • Weight: Both groups of stocks accounted for over 60% of the performance of their respective local equity markets last year. Their constant outperformance has continually increased their weight in the respective blue-chip indices in recent years. With a combined weight of more than 25% in the Stoxx 600 (GRANOLAS) and almost 30% in the S&P 500 (Mag 7), that handful of stocks is increasingly determining the trajectory of equity markets on both sides of the Atlantic these days.
  • Fundamentals: In both cases, the stellar performance of the GRANOLAS and the Mag 7 is no accident, but has been driven by rock-solid fundamentals. On one hand, their share-price gains are based for the most part on corresponding corporate earnings growth. And on the other hand, both groups of companies are outgrowing the rest of the equity market by a factor of three to four times and are doing that with less sensitivity to fluctuations in economic activity. And the explanation for this above-average growth is the same for both the European and the American champions. The GRANOLAS and the Mag 7 both spend around three times more on research, development, and other investment expenditures than the rest of the companies on the equity market do. In addition, they also resort to acquisitive growth more frequently than other companies do. The eleven GRANOLAS companies, for example, were involved in almost half of all M&A transactions in the Stoxx 600 over the last five years.
  • Capital flows: However, the fundamentals are not the only explanation for the better-than-average performance on both sides of the Atlantic. The structural shift toward passive investments is a global trend. When investors withdraw money from active funds to invest it in ETFs, this benefits the largest companies the most. What was already big thus tends to get even bigger.
  • Valuation: Last but not least, the two groups also have high valuations in common. The heavyweights in Europe have a 60% higher price-to-earnings ratio than the broad market, and the P/E premium in the USA stands at 50%. However, adjusting for the robust growth, rich cash flows, and earnings quality makes the valuation premium on both sides of the pond appear to be at a “fair” level.

 

Highly concentrated | The big are getting bigger and bigger also in Europe

Weight of the GRANOLAS in the Stoxx 600 index

Sources: Bloomberg, Kaiser Partner Privatbank

 

…and differences relevant from an investment standpoint

Despite the many things they have in common, viewing the top stocks in Europe versus their counterparts in the USA is more like comparing apples with oranges than comparing fruit from the same crate. And the differences are definitely of relevance for investors.

  • Volatility: The (out)performance by the GRANOLAS is very attractive not just in absolute terms, but also on a risk-adjusted basis. The GRANOLAS are much less volatile than the broad market and other growth stocks. Since 2018, those 11 European stocks have exhibited realized volatility that is only around half as high as that of the Mag 7 in the USA. This means that in recent years, an investor could notably reduce a portfolio’s risk/return ratio by blending in the GRANOLAS.
  • Diversification: The Mag 7 are almost all technology companies. The GRANOLAS encompass the technology sector, but also the healthcare, consumer staples, and discretionary consumer goods industries and therefore are a much more broadly diversified bet.
  • Dividends: The GRANOLAS place a high priority on shareholder value. Their dividend yield of 2.5% on average far exceeds the dividend yield of the S&P 500 (1.5%) and the Mag 7 (0.3%). US technology companies compensate for their dearth of payouts by frequently buying back their own stock. But even if the dividend and buyback yields are added together, stocks in the European Champions League yield around 2 percentage points more than the Mag 7 do. Last but not least, the GRANOLAS are also more attractive than the real yield on German government bonds (0.3%) and US Treasurys (1.6%).

 

Profitable growth | Advantage: Europe

Yield comparison (dividend yield and real bond yield)

Sources: Bloomberg, Kaiser Partner Privatbank

 

Buy or wait?

The high-growth quality of the big “made in Europe” companies has paid off for their shareholders in recent years. The stock prices of the GRANOLAS have increased more than twofold since 2018 while the rest of the market has treaded water. The characteristics of the GRANOLAS – robust earnings growth, low volatility, high and stable profit margins, sound balance sheets, and sustainable dividends – are likely to remain in demand also during the further course of this decade. If those stocks retain their qualities, there’s a high probability that investors can expect to continue earning positive absolute returns with them in the future because many of those companies operate in the sweet spot of structural megatrends such as demographic aging, artificial intelligence, and automation.

 

Qualitative growth pays off | The GRANOLAS have massively outperformed

Performance comparison: GRANOLAS vs. broad market, indexed (Jan. 1, 2018 = 100)

Sources: Bloomberg, Kaiser Partner Privatbank

 

However, there is no guarantee that the European heavyweights will keep on outperforming the broad market. Historical evidence shows that if market leaders don’t constantly reinvent and further develop themselves, they can get overtaken by smaller and nimbler competitors. This cyclical nature of markets and trends is also reflected in the ranking of the top ten stocks in Europe, which, though static in the short term, is relatively dynamic over a period of ten years and longer. And the outperformance by the GRANOLAS could even stall out in the nearer term, at least temporarily. If economic activity in Europe revives, cyclical companies with less muscular balance sheets might perform better intermittently. Also, in the event of a strengthening euro, the 11 big companies, which generate less than 20% of their revenue in Europe, would arguably fall behind small caps focused on the domestic market. And last but not least, for quite some time now, the GRANOLAS, like the Mag 7, have been an overbid bet that many market participants have already joined in on. So, to buy or not to buy (yet)? There’s no way around the European Champions League for whoever would like to invest in Europe’s equity market. But in the wake of the torrid rally of late, above-average exposure to the GRANOLAS is not necessary at the moment.

 

Change… | …is the only constant

Top 10 in Stoxx 600 index over time

Sources: Goldman Sachs, Kaiser Partner Privatbank

 

Oliver Hackel, CFA Senior Investment Strategist

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