While the recent melodramatic clashes between eurozone members have been horribly painful for its citizens, the economic churn has lifted quality companies to the top.
“Good businesses get stronger when there’s a problem. They do the right things to make the business grow and that gets rewarded in the share price,” says Dean Tenerelli, the pragmatic straight-talking European equity manager at T Rowe Price.
Whether he’s talking about Spanish media companies or UK burger chains, Mr Tenerelli refuses to allow his investment thesis to become mired in the macroeconomic maelstrom. Instead, he doggedly pursues bottom-up, value-based stock picking, guided by a stringent discounted free cashflow overlay.
“What most people do is take the free cashflow and forecast it out many years and then at the end of that period come up with a magical terminal growth number, usually 2-3 per cent,” he explains. “I put zero. I’m very strict on not paying for growth after a certain period.”
By taking such a conservative approach to stock valuations – only accounting for what he calls “visible growth” of the next couple of years – Mr Tenerelli says he has managed to override emotion-led rationales for avoiding certain stocks, instead allowing the quantitative analysis to lead him to stocks that he would otherwise be “scared to death to buy”.
Putting his two decades of investment experience to use, Mr Tenerelli has been vocally bullish on European banks, stating that within three years European banking stocks won’t be available below book value. While today sees depressed bank earnings, weak profit outlooks, regulatory upheaval and bad legacy assets, Mr Tenerelli says there are sound reasons for the tough times faced by banks. However, from rock bottom, with regulatory calm and strengthening global growth, the only way is up.
“Six months ago if you talked about recovery, people would have laughed at you,” he says. “It’s a stockpicker’s paradise when the market has sold them off and [banks] are just really, really cheap.”
The illiquidity that froze banks – the ‘credit crunch’ precursor to what became a full-blown global financial crisis – made a lasting impression on Mr Tenerelli. “This theme of absolute risk aversion and [subsequent] illiquidity repeats itself throughout time, in different instruments and in different situations in the world economy, but one thing is always the same: it’s a big problem,” he says somberly.
“Watching that unfold… I had never seen anything in my life that was [like that]… I found it really intellectually fascinating, and, very dangerous.”
Mr Tenerelli explains that a cashflow-focus is a useful “reality check” when markets display bubble characteristics, overheating and generating sky-high valuations on companies with little or no free cashflow. Moreover, it helps identify ‘cream of the crop’ companies with decent free cashflow and resilient business models but which are trading at low share prices.
He says: “Last year, my valuation measures showed so much upside that I was buying media companies in Spain and France during the third and fourth quarter when we expected the recession to be even worse the following year… Well all that stuff is up roughly 80 per cent this year. I was able to buy it because my focus was on valuation. They came out so ridiculously cheap that I had no choice but to buy it if I’m following my investment style.”
