by Mandana Hormozi, & Tim Rankin, Portfolio Managers, Research Analysts, Franklin Mutual Series
Franklin Mutual Series sees value opportunities across Europe as efforts to improve competitiveness, potential political change in Germany and a focus on shareholder returns boost market sentiment.
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 regionās competitiveness, declining interest rates, and a potential political change in Germanyāalong with a focus on greater shareholder returnsācould 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
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, Europeās 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
Policymakers may finally be taking steps to improve the regionās 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 Draghiās 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 Europeās 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 governmentās 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
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
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
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.
WHAT ARE THE RISKS?
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Equity securitiesĀ are subject to price fluctuation and possible loss of principal.
International investmentsĀ are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified inĀ emerging markets.
Value securitiesĀ may not increase in price as anticipated or may decline further in value. Growth or value as an investment styleĀ may become out of favor, which may have a negative impact on performance.
Active managementĀ does not ensure gains or protect against market declines.
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