Is there still a case for investing in European smaller companies?

The law is commonly framed as follows: “Any headline that ends in a question mark can be answered by the word ‘no’.” Classic recorded examples include “Could Pokemon Go swing the November election?” and “Is it time to start taking Eurovision seriously?”.

You may think this article is perfectly placed to add to the canon. After all, predictions around European economic and productivity growth – or, to be more precise, the relative lack of it – are generally gloomy, while uncertainty over monetary policy continues.

Nonetheless, I hope to buck the trend. I believe the case for investing in European smaller companies is still strong – and I also believe it could become even stronger over the next few months.

To understand why, we first need to consider the circumstances that appear to undermine the region’s hopes of attracting greater investor interest. We then need to explore why many of these dynamics could ultimately work in smaller companies’ favour.

A tale of multiple headwinds

Published in May, the European Commission’s Spring Forecast projected 2024 GDP growth of 1% in the European Union (EU) and 0.8% in the eurozone (EZ). The EU figure was slightly up from the Winter Forecast, while the EZ figure was unchanged.

For 2025 GDP growth, meanwhile, estimates were revised down in both instances – to 1.6% for the EU and 1.4% for the EZ. The most stirring term the Commission was able to muster in describing the way ahead was “gradual expansion”¹.

It is likely some or all of these numbers will be tweaked again before year’s end. They could even improve. But the chances are that they will stay decidedly underwhelming in any event.

There are many reasons for the slowdown. They include government overspending in the wake of the COVID-19 pandemic, ongoing geopolitical tensions – most obviously in the form of the conflict in Ukraine – and doubts over the prospect of further interest rate cuts.

The pain is being felt everywhere, in part because nations have little choice but to fit into a bigger economic picture. As the disastrous UK mini-Budget under Liz Truss’s short-lived aegis proved, it is nigh on impossible for individual countries to somehow carve out their own genuinely distinctive path.

A granular approach to growth

Yet the reality is that Europe has never been regarded as a high-growth region. Moreover, it probably never will be. As investors, we should aim to gauge its appeal at a more granular level – by sector, by industry or, arguably most compellingly, by business.

It is through the last of these lenses that the brightest opportunities are likely to be identified. Irrespective of the broader economic environment, Europe is still home to quality companies with a capacity to benefit from sound management and solid operating models over the long term.

Many lurk in virtual anonymity at the lower end of the market-capitalisation spectrum. They are frequently under-researched, underappreciated and – crucially – undervalued. The more Europe is perceived to be struggling, the cheaper these hidden gems are likely to be.

Even promising mid-cap stocks are routinely escaping mainstream notice. Finnish company Orion, which develops and manufactures human and veterinary pharmaceuticals, offers a striking illustration.

Orion was briefly among our holdings five years ago. Earlier this year, when we decided to invest in the business again, its share price was lower than it had been half a decade earlier – yet it has since risen from around €32 to around €48².

Patience, potential and further promise

A company like Orion is typical of the smaller European stocks we try to seek out. Its story in many ways encapsulates the kind of holding we feel should have a place in a sensibly diversified, long-term-focused portfolio.

The business has suffered disappointments, yet it has consistently demonstrated resilience through difficult periods. It has repeatedly failed to garner the attention of the wider investment community, but it now looks set to reward the patience of those who recognised its potential.

More smaller European companies could follow this route as we head into 2025. This may be particularly likely if the trend of “gradual expansion” endures, central banks’ thinking becomes clearer and slowdown does not translate into a manifest decline in activity.

Until then, with low valuations still rife, the scope for “getting in on the ground” should remain significant. “Early adopters” can expect to get the most out of the recovery and subsequent rise of these businesses’ share prices.

So have I succeeded in defying Betteridge’s Law? Compliance requirements alone prevent me from suggesting the answer to this article’s headline should be a resounding “yes”, but I would like to think a “maybe” – and perhaps even a definite one – is more than justified.

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David’s article was first published on Professional Adviser on 07/10/24

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¹See, for example, European Commission: “Spring 2024 Economic Forecast: a gradual expansion amid high geopolitical risks”, May 15 2024

²As at September 4 2024. See, for example, Orion Corporation: “Share chart”

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Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.‍‍