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Time to swim against the tide and invest in European equities

It is all too easy to overlook Europe at the moment.

From an investment perspective, the region as a whole is in recession and the political challenges that lie ahead are huge.

However, what is occurring at the macroeconomic level should not be confused with where and how European companies make their money. Europe is home to a number of world-class companies with global revenue streams. Many have significant exposure to Asian and emerging markets, and are not reliant on demand from Europe. These global ties relate to historic footprints across the globe, as well as in some cases a particularly small domestic market.

Furthermore, regardless of the euro's destiny, Europe's status as a manufacturing and technological powerhouse will not simply evaporate overnight, given that the EU represents more than 20% of global GDP. Indeed, the region's resilience to political and economic shocks has been proven many times throughout the course of history. A popular, though simplistic, argument in favour of European equities at present is that they are cheap.

It is true that at times European-listed but globally orientated companies have traded as if they were purely domestic ones. Such indiscriminate selling has created opportunities to buy quality companies at attractive valuations.

However, while in aggregate European equities are cheap, companies with strong balance sheets, global revenue streams and significant pricing power could be considered as fairly valued by traditional valuation methods. Despite this, we still see potential in a number of strongly positioned businesses in Europe which, in our opinion, not only have sustainable earnings but are capable of growing them.

And with their balance sheets largely repaired, the return of cash to shareholders via growing dividend payouts is extremely valuable. The importance of yield cannot be overstated. Dividends act as a touchstone for the health of a company and encourage a disciplined and long-term approach to its management.

The scarcity of income at the moment, and the modest valuations of many companies, make now a particularly attractive time for equity income investment. Dividend yields are attractive absolutely and some selected dividend yields are near multi-year highs. Earnings forecast may be under some pressure, but dividend prospects look capable of withstanding all but the most severe downturns.

Our approach to investing in Europe looks to cut out the market noise. By doing so we are able to uncover the investment gems among the rubble, using times of market stress to top up on favoured companies. Keeping calm while others around are losing their heads and focusing on quality businesses over the long term is a simple strategy, but this by no means makes it easy.

It can be difficult to ignore the herd and stick your head above the parapet because the fear of being wrong tends to hold people back. However, Europe is perfectly suited to this unflinching stock-picking approach, where indiscriminate selling can uncover a breadth of opportunities.

Investing in European shares at the moment would therefore be considered as contrarian. Yet many of the greatest investment opportunities have been unconventional at the time, but with the benefit of hindsight seemed obvious once the dust had settled. We have found successful investing generally requires thinking differently and feel now could prove to be a rewarding time to buy continental European equities.

Jeremy Whitley is head of Pan European Equities at Aberdeen Asset Management

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