Equities Blog

European Industrials: A Hotbed of Growth for Equity Investors

12 June 2024

5 min read

Today’s industrial business models offer surprising sources of consistent earnings growth.

Investors seeking growth in European equities might be discouraged by the lack of technology titans that dominate US markets. But Europe is home to a different type of growth, thanks to industrial companies that offer diverse sources of return potential.

When investors think about growth stocks, industrials aren’t usually the first thing that comes to mind. Industrial businesses are often perceived to be tied to macroeconomic cycles—hardly the types of companies that equity investors associate with consistent, long-term growth.

Gauging the Growth Profile

But in Europe, that perception isn’t quite right. In fact, industrials are the largest sector in the MSCI Europe Growth Index with a 22% weight (Display). That’s nearly four times the weight in the comparable US benchmark, where the Russell 1000 Growth Index is technology heavy.

Industrial Stocks in Europe Offer Attractive Earnings Growth Potential

Left chart shows MSCI Europe Growth and Russell 1000 Growth index weights for the industrials and technology sectors. Right chart shows consensus earnings growth forecasts for those sectors in each index.

Current analysis and forecasts do not guarantee future results.
As of April 30, 2024
Source: Bloomberg, FTSE Russell, MSCI and AllianceBernstein (AB)

As a sector, European industrials offer solid and improving earnings growth. Consensus earnings estimates for industrials in the MSCI Europe Growth Index are expected to increase from 11.9% in 2024 to 15.9% in 2025 (Display). That’s in line with next year’s earnings estimates for the US technology sector. In the European growth benchmark, the technology sector includes only 15 stocks and is dominated by two large companies, so earnings can be volatile.

But how can a growth-oriented investor know that an industrial stock isn’t cyclically exposed? We think it all comes down to a company’s business model and its specific product or service offering. For example, companies that are leaders in niche industrial markets with little competition often enjoy consistent growth by virtue of strong market shares and competitive advantages that underpin pricing power.

Profitability metrics provide valuable intelligence. Our research suggests that there are more companies with above-median profitability and earnings growth in the European industrial sector than in any other European growth sector (Display). High return on invested capital is a good indicator of underlying business quality, which helps support structurally above-market earnings and cash-flow growth through the business cycle.

Many Industrial Companies Offer Attractive Profitability Profiles

Two pie charts show the number of companies by sector with higher-than-median profitability and earnings growth in the MSCI Europe Growth index.

Current analysis and forecasts do not guarantee future results.
Total number of companies in MSCI Europe Growth Index is 193. Charts represent the number of companies within the group of 93 companies in the index whose return of invested Capital (ROIC) and earnings growth are above the median of the broad market. Analysis excludes companies for which no data are available. Earnings growth is based on consensus analysts estimates of forward earnings growth for the next 12 months.
EPS: earnings per share.
As of May 31, 2024
Source: Bloomberg and AB

Three Attractive Business Models

Within the sector, we see three business models that can provide durable sources of long-term growth potential.

Services and spare parts providers. For some firms, selling the initial industrial tool or machine is often just the gateway to a stream of longer-term cash flows. Industrial workhorses require a regular supply of spare parts and services to keep them humming without interruption. Spare parts and services are typically not discretionary items; they generate recurring purchases and often must be bought from the original equipment manufacturer, which means they command high margins.

Look for clues in revenues. We distinguish between revenues driven by capital expenditures (capex) and operating expenditures (opex). Capex orders are big onetime purchases, such as a massive mining machine, and are more sensitive to macroeconomic cycles. In contrast, opex represents recurring spending, like the spare parts or servicing for mining equipment, which tends to be much less exposed to the business cycle.

Serial acquirers and consolidators. In fragmented market segments, some companies can augment a competitive edge with strategic acquisitions. That might involve buying small local competitors and then stepping up purchases of regional and even global businesses.

Digital transformers. The line between technology and industrials is blurring. Many industrial products are being adapted for the digital age with connectivity devices, data-capture sensors and software capabilities. Europe might not have AI leaders like the ones in the US. But European industrial businesses are enabling AI, such as manufacturers of electrical cables, switchgears, circuit breakers and transformers used in data centers and the wider electrical grid. These companies provide advantages for investors: you don’t need to bet on a specific AI technology leader, since these industrials benefit from the broader AI growth trend.

Visibility Supports Consistent Return Potential

These types of growth drivers aren’t mutually exclusive. Industrial companies with one or more of these business model features offer attractive investment opportunities, in our view.

Mapping out the right parameters can unearth exciting industrial firms that bear little resemblance to the capital-intensive smokestacks of the past. And by applying a consistent fundamental research framework, selective equity investors can discover industrial businesses with much clearer visibility of their paths to future growth—and long-term returns.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.

MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein.

The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.

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