Investors in European stocks are facing multiple sources of risk. Applying the mindset of strategic business owners can help tune out the noise and sharpen investors’ focus on more resilient sources of return potential.
Equity markets in Europe offer attractive return potential in an environment of persistent low bond yields. Yet the macroeconomic background is complex. And a busy election calendar is creating a deafening volume of political commotion across the continent. For investors seeking to tap equities, it may seem hard to develop conviction in the fundamental qualities of companies that should drive stock returns over the long term.
DEVELOPING A PRIVATE EQUITY MINDSET
But there is a way to stay focused on sustainable sources of return potential. We favor approaching public equity markets with the mindset of strategic business owners, like private equity investors. They think and operate very differently from most investors in public markets—and their time horizons tend to be longer, typically around five years.
So, which private equity investing techniques can deliver particularly valuable long-term perspectives?
1. FOCUS ON BUSINESS STRATEGY, OPERATIONS AND MANAGEMENT
Investors in equity markets often focus on financial-market metrics such as a stock’s beta or its volatility. But these types of indicators don’t tell an investor anything about whether a business will be successful or not. Private equity investors seek to buy companies—not stocks. They focus their lens on business strategy, operations, market dynamics and management. These are the things that really drive value creation for a company, and ultimately deliver returns to investors.
Business owners always scrutinize a company’s balance sheets, aiming to ensure companies aren’t artificially amplifying their returns on equity by taking on excessive debt. And the quality of a management team is also key to improving the chances of successful execution of business and financial plans.
2. EMPHASIZE CASH FLOWS
Cash flows are perhaps the most important indicator of a company’s business health. While many investors in stocks put earnings at the center of their analysis, private equity investors tend to focus more on cash flows, which can’t be manipulated as easily as reported earnings figures. They provide transparency on how much cash is flowing in or out of the company in the form of working capital and capex spending—which don’t show up in reported earnings. Cash-rich companies are clearly getting a lot of things right, suggesting they could prove to be well placed to invest in their businesses in ways likely to enhance their earnings potential.