CONTRIBUTORS
Mandana Hormozi
Portfolio Manager, Research Analyst
Franklin Mutual Series
Timothy Rankin, CFA
Portfolio Manager, Research Analyst
Franklin Mutual Series
European stocks get little love. However, we think the yawning valuation discount of European equities to their US peers (see Exhibit 1) may be too wide for investors to ignore. Efforts to improve the region’s competitiveness, declining interest rates, and a potential political change in Germany—along with a focus on greater shareholder returns—could spark a revival. Europe is a market where value opportunities are loudly knocking, and we believe the early 2025 strength in local markets may continue.
Exhibit 1: The Valuation Gap between US and European Stocks Has Widened
MSCI Europe Index/MSCI USA Index
Next 12-Month P/E Ratio
January 31, 2010–January 31, 2025
P/E = price/earnings
Source: FactSet. The MSCI USA Index is designed to measure the performance of the large- and mid-cap segments of the US market. The MSCI Europe Index captures large- and mid-cap representation across 15 developed markets countries in Europe. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results.
Sparking an economic revival
The economic picture in Europe has been mixed at best in recent quarters. Growth has been weak on the continent, particularly in Germany, but has been a bit brighter in parts of Southern Europe and the United Kingdom. Germany, Europe’s largest economy, saw growth slide in 2024 and is projected to post slight 0.3% gross domestic product (GDP) growth in 2025, according to an estimate from the International Monetary Fund. Growth in France and the United Kingdom should be a bit faster, while Spain is showing some of the fastest growth in the region in 2024 and 2025 (see Exhibit 2). In parts of Europe, growth appears to be improving.
Exhibit 2: European Economic Growth: Sluggish but on the Path to Improvement from a Low Base
Gross Domestic Product Growth
E = Estimate
Sources: National Statistics Bureaus, International Monetary Fund. UK 2024 GDP growth is estimated. There is no assurance that any estimate, forecast or projection will be realized.
Policymakers may finally be taking steps to improve the region’s competitiveness and economic vigor. Former European Central Bank (ECB) head Mario Draghi released a 400-page report on steps the region should take to do just that, including spending a sizable sum on electrification, infrastructure and research and development. It also calls for fiscal consolidation and greater support for merger activity to help improve returns.
We see early signs the European Union (EU) is serious about adopting some of Draghi’s suggestions. Should even a portion of the proposals come to fruition, we believe it would be positive for the European economy and regional markets.
The ECB also has been cutting interest rates to support swifter economic growth. However, inflation continues to stir, and energy markets remain vulnerable to shocks from supply disruptions, which can upend the economic outlook. Potential US tariffs are also a concern.
Shifting politics could ignite growth
A political change in the upcoming German election may also help. The current center-left government looks likely to lose to a center-right coalition, which could spark a series of initiatives to boost economic growth through more infrastructure spending after years of neglect and by seeking to reduce energy prices and cut taxes.
Faster growth in Europe’s largest economy would be positive for the region overall and for equity markets, in our view, as it would reinforce the efforts taking place at the EU level to foster a more competitive continent.
Additionally, we are seeing early indications that a peace deal in Ukraine may be possible. While still highly uncertain, a deal could boost domestic confidence as a major conflict in the center of Europe ends. Moreover, European companies may have an opportunity to help rebuild the country, and we see potential for energy costs to fall again in the wake of a ceasefire.
In the United Kingdom, some of the Labour government’s early missteps have been disappointing, but we are optimistic that growth will remain solid, and that UK policymakers will continue to take a more pragmatic approach to the EU after a decade of chaotic post-Brexit economic policy.
Value abounds
For global value investors, we think Europe remains fertile ground for finding companies trading at cheaper valuations while offering solid or improving global businesses that could eventually spark a re-rating. Consensus estimates suggest that corporate earnings growth for the region could get a bounce in the coming year (see Exhibit 3).
Exhibit 3: Company Earnings Growth Improvements Could Spark a Re-Rating
Earnings per Share, Year-over-Year, Consensus Estimates
E = Estimate
Sources: FactSet, MSCI, FactSet Market Aggregates. As of January 16, 2025. The MSCI EMU Index (European Economic and Monetary Union) captures large- and mid-cap representation across the 10 developed markets countries in the EMU. The MSCI United Kingdom Index is designed to measure the performance of the large- and mid-cap segments of the UK market. The MSCI USA Index is designed to measure the performance of the large- and mid-cap segments of the US market. The MSCI World Index captures large- and mid-cap representation across 23 developed markets countries. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. MSCI makes no warranties and shall have no liability with respect to any MSCI data reproduced herein. No further redistribution or use is permitted. This report is not prepared or endorsed by MSCI. See franklintempletondatasources.com for additional data provider information.
European companies are generally global companies, with about 27% of total revenue for the MSCI UK Index and 25% of total revenue for the MSCI Europe ex UK Index coming from the United States. We believe these companies should not be penalized with cheaper valuations simply because of where they have listed. These multinationals can offer investors global and US exposure, often at more attractive valuations than their US peers.
UK stocks look particularly cheap relative to other regional markets, in addition to their US counterparts, which may offer opportunities to find a range of companies which could narrow these valuation gaps over time (see Exhibit 4).
Exhibit 4: UK Market Valuations Look Appealing Relative to Europe Overall
MSCI Europe Index vs. MSCI UK Index
Next 12-Month P/E Ratios
January 31, 2010–January 31, 2025
Source: FactSet. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. See franklintempletondatasources.com for additional data provider information.
We see plenty of domestically focused opportunities as well. Banks are one area where companies could benefit from improving economic growth and from efforts to push regional consolidation and improve competitiveness. Although we have seen little loan growth recently in Europe, lower interest rates and faster economic growth could drive increased loan demand and be positive for regional banks.
The right shareholder return profile
Companies are also focusing more on adding stock buybacks to their already significant dividend policies. While we are not ready to say European companies are becoming as shareholder-friendly as US firms, they are clearly more focused on offering better returns on invested capital (see Exhibit 5).
Exhibit 5: Net Buybacks as a Percentage of Market Capitalization on the Rise
Net Buybacks as a Percentage of Market Capitalization
Sources: FactSet, S&P Dow Indices, MSCI. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. See franklintempletondatasources.com for additional data provider information.
Balance sheets look strong, so if there are opportunities to invest free cash flow in tangible growth initiatives, or in mergers in areas like telecoms or financials to reduce competitive intensity, or in stock buybacks, we would generally view the moves favorably.
European companies have also paid sizable dividends. According to data from MSCI, as of December 31, 2024, UK companies in the MSCI UK Index offer an overall dividend yield of 3.76% versus 3.26% for the MSCI Europe Index and a paltrier 1.27% for the MSCI USA Index.1 Any effort to supplement these robust dividends with additional capital returns can provide investors with an additional reason to focus on European stocks.
For investors willing to look past the current sluggish growth and ongoing political uncertainties, which appear headed toward resolution, we believe Europe offers prospects to find attractively valued companies with ample opportunities to spark a revival in their share price through improving growth, global focus or better shareholder returns. Europe is calling.
Endnote
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Dividends may fluctuate and are not guaranteed, and a company may reduce or eliminate its dividend at any time.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Equity securities are subject to price fluctuation and possible loss of principal.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
Value securities may not increase in price as anticipated or may decline further in value. Growth or value as an investment style may become out of favor, which may have a negative impact on performance.
Active management does not ensure gains or protect against market declines.