Why I Believe in European Small Caps
Weekly 49 2024 - Portfolio overview
It’s safe to say that Europe hasn’t been the land of milk and honey over the past 15 years. The GDP grew by only 0.8% annually during this period, while inflation was anything but low the last few years.
On top of that, we have the war in Ukraine, causing severe disruptions in material supplies. The most impactful consequence, however, was the halting of Russian gas deliveries, combined with the phase-out of nuclear energy in countries like Germany and Belgium. These developments made energy unnecessarily expensive in Europe.
On top of that, Europe’s overregulation, high taxes, and a frequently business-unfriendly attitude further complicated matters.
Yet, despite all these headwinds, we still see strong, high-quality, and profitable companies in Europe. These are businesses that not only survive in a challenging environment but also grow and deliver impressive profits. These are resilient companies—undeniably so.
Why Would the Future Be Different From the Past 15 Years?
Because the pendulum in Europe has swung too far in one direction. In other words, a counterreaction is inevitable. Whether we’ve hit rock bottom yet is uncertain, but things can’t deteriorate much further without causing irreparable damage.
Once societal pressure becomes too great, policymakers will change course. The media narrative will also shift, potentially marking the beginning of better times.
Europe vs. America: The Growth Comparison
A common counterargument is: “Yes, but look at America’s growth.” Over the past 15 years, the U.S. GDP grew by an average of 4.2% annually, significantly outpacing Europe’s 0.8%.
However, these figures are partly thanks to the rise of American tech giants, which have gained dominant global positions. Outside of this sector, the rest of the U.S. economy didn’t necessarily outperform Europe’s, especially when you consider how this growth was achieved.
The Role of Debt in Growth
In Europe, the debt burden rose from $9.598 trillion in 2008 to $14.606 trillion at the end of 2023. This increase—from 58.9% to 79.6% of GDP—was largely driven by the pandemic.
In the U.S., the rise was even more dramatic. Government debt grew from $9.426 trillion to $30.203 trillion during the same period, jumping from 63.8% to a staggering 110.4% of GDP.
In other words, a significant portion of U.S. growth was fueled by government debt. However, this strategy has its limits, and even the U.S. will eventually hit the ceiling of what markets will tolerate.
My Conclusions
Can the U.S. Sustain This Growth?
The ceiling for debt—and debt-fueled growth—is near. It’s unlikely that a new sector will emerge to match the impact of the tech giants. As a result, valuations for a lot of U.S. companies appear excessively high. (Note: this isn’t criticism of the U.S. itself but of the prices paid for its growth.)Europe Is at a Turning Point.
Change must occur to prevent irreversible damage. Politicians will adjust their course because, ultimately, self-preservation outweighs ideology. Human nature ensures this will happen.Valuation Gap Between Europe and the U.S.
For every euro of profit, you pay 40% less in Europe than in the U.S. Capital seeking returns will increasingly look to Europe.
The Role of European Capital
American investors are unlikely to invest in Europe, apart from a few exceptions. But they don’t need to. In recent years, €300 billion of European savings has flowed annually to the U.S.—more than the total market value of the Brussels stock exchange without AB InBev.
If European capital stays within Europe in the future—or even partially returns—valuations here could rise quickly.
A Case in Point: Smartphoto
A small article by my friend Pieter (“Compounding Quality”) in a Belgian newspaper was enough to boost Smartphoto’s share price by 10%. This is typical of small caps: once buyers recognize their value, the price can rise sharply.
You can find my original analysis of Smartphoto here.
Doubler Portfolio Overview October 2024
For those not yet familiar with our Doubler Portfolio, read more about it here.
On Tuesday, I wrote about facing a -4% loss, but today that’s no longer the case—2% has already been regained. The stock market can turn quickly.
November: A Weak Month
November was a tough month for our portfolio, much like it was for many European small caps. The election of Trump intensified capital flows to the U.S., putting additional pressure on European stocks.
I’m not expecting much improvement in December, to be honest. Trading often slows in the final weeks of the year. Many fund managers clean up their portfolios by selling losing positions so these don’t appear in year-end reports. This often means existing trends persist—and right now, that’s not working in our favor.
By the end of November, our portfolio stood at -2.9%. That’s not the start I had hoped for, but it’s also not a surprise.
Why This Portfolio?
The Doubler Portfolio was launched with the belief that the turning point for small, quality European stocks is near. Timing the exact bottom is nearly impossible and would have been pure luck. As Joel Greenblatt aptly put it:
“Unless you buy a stock at the exact bottom (which is next to impossible), you will be down at some point after you make every investment. Your success entirely depends on how dispassionate you are towards short-term stock price fluctuations. Behavior matters.”
You’ve already read above why I’m focusing on European small caps.
Position and Outlook
At the end of November, about 60% of the portfolio was invested. For the remaining 40% in cash, we have plenty of candidates, including opportunities to expand some existing positions. However, we’re sticking to our plan of gradual investments.
The goal isn’t to outperform the market this year but to double our money in 5 to 7 years—with a clear preference for five years, of course.