The European valuation opportunity

• The stock-picking opportunity within cash generative stocks looks particularly pronounced currently.

• The Cashflow Champions Watchlist is the third cheapest it has been in the last 30 years.

• We expect the strong historic relationship between low valuation and subsequent investment performance to hold true in future periods.

The valuation of Europe’s most cash-generative stocks look very attractive. In fact, this cohort – which we capture in the Cashflow Champions Watchlist – has only been cheaper on two occasions in the past 30 years. To explain the significance of the Watchlist and the current European valuation opportunity, we first need to discuss the Cashflow Solution investment process.

Seeking out cash generative stocks with conservative management

At the heart of the Cashflow Solution investment process is a focus on companies’ historic cash flows and how these are generated and invested. We believe that companies run by conservative managers focused on delivering good cash flow perform significantly better than companies run by aggressive company managers making large cash investments today to chase over-ambitious future growth targets.

Our starting point in analysing the European stock universe has always been the application of two core cash flow ratios. Only the top 20% of this ranked universe – the Cashflow Champions Watchlist – qualify for potential investment in the funds we manager. We then carry out fundamental analysis on the Watchlist, profiling each stock’s cash flow characteristics based on detailed analysis of companies’ report and accounts.

Adjusting style bias to reflect market conditions

In combination with analysis of market direction and investor dynamics, we can then tilt the portfolio towards certain cash flow characteristics and style factors depending on the prevailing investment backdrop.

The Fund has adopted a range of style biases over the last decade, as we have dynamically responded to the investment backdrop at any given time. This has enabled the process to deliver attractive returns across different market environments.

Several years ago, cash generative companies with growth characteristics were a mainstay in portfolios, but as stockmarkets tumbled at the start of 2020 due to the threat of Covid-19, all our indicators were signalling the need to re-shape portfolios with a heavy emphasis on unloved value stocks. At the same time, stocks with high forecasts of growth were looking overvalued and vulnerable, so we trimmed this exposure right back.

Style leadership has become less pronounced, but the European valuation opportunity is compelling

This underweight exposure to high forecast growth stocks and large position to unloved value companies was a very rewarding position in subsequent years. Over the last year or so, the style leadership of the market has been more balanced and we have repositioned portfolios to reflect this. This means that shorter-term performance has been driven by stock-picking returns to a greater extent than style tilt.

The stock-picking opportunity within cash generative stocks now looks particularly pronounced. Our recent analysis of the top 20% of stocks ranked on our core cash flow ratios – on a combined one-year and five-year basis – highlights just how attractive the current valuation opportunity is:

Cashflow Champions Watchlist valuation, Europe 

Source: Liontrust, as at 30.09.24. Z-score of the valuation of top 20% of European stocks ranked by combined cash flow ratios

Click here to open a larger version of this chart in a new window.

This long-term data suggests the Cashflow Champions Watchlist has only been cheaper on two other occasions over the last 30 years – in 2001 and in 2020.

Both of these points proved to be excellent historic entry points to the Cashflow Solution investment process, and we think this time will be no different. There should continue to be a strong relationship between low valuation at investment and subsequent strong performance.

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KEY RISKS

Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested.

The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.

The Funds managed by the Cashflow Solution Team:

May hold overseas investments that may carry a higher currency risk. They are valued by reference to their local currency which may move up or down when compared to the currency of a Fund.
May have a concentrated portfolio, i.e. hold a limited number of investments. If one of these investments falls in value this can have a greater impact on a Fund's value than if it held a larger number of investments. May, under certain circumstances, invest in derivatives, but it is not intended that their use will materially affect volatility. Derivatives are used to protect against currencies, credit and interest rate moves or for investment purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions. The use of derivatives may create leverage or gearing resulting in potentially greater volatility or fluctuations in the net asset value of the Fund. A relatively small movement in the value of a derivative's underlying investment may have a larger impact, positive or negative, on the value of a fund than if the underlying investment was held instead. The use of derivative contracts may help us to control Fund volatility in both up and down markets by hedging against the general market. The use of derivative instruments that may result in higher cash levels. Cash may be deposited with several credit counterparties (e.g. international banks) or in short-dated bonds. A credit risk arises should one or more of these counterparties be unable to return the deposited cash. May encounter liquidity constraints from time to time. The spread between the price you buy and sell shares will reflect the less liquid nature of the underlying holdings.Outside of normal conditions, may hold higher levels of cash which may be deposited with several credit counterparties (e.g. International banks). A credit risk arises should one or more of these counterparties be unable to return the deposited cash. May be exposed to Counterparty Risk: any derivative contract, including FX hedging, may be at risk if the counterparty fails. May target an absolute return. There is no guarantee that an absolute return will be generated over the time period stated in the fund objective or any other time period.

The risks detailed above are reflective of the full range of Funds managed by the Cashflow Solution Team and not all of the risks listed are applicable to each individual Fund. For the risks associated with an individual Fund, please refer to its Key Investor Information Document (KIID)/PRIIP KID.

DISCLAIMER

This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. Always research your own investments. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.

This should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, forwarded, reproduced, divulged or otherwise distributed in any form whether by way of fax, email, oral or otherwise, in whole or in part without the express and prior written consent of Liontrust.