abrdn: Are UK smaller companies the most unloved stocks in the world?

UK smaller companies are the most unloved stocks in the world, new research by abrdn suggests.

The global investment company looked at the 12-month forward P/E ratio (a key metric investors use for valuing a stock or index) across major small and large cap indices and found that UK smaller companies are currently trading at a discount of -23.4% to their 10-year average (data up to 31^st January 2025). This is the widest of any major region – see table below.

abrdn looked at the 12-month forward P/E ratio, which compares current share prices to estimated future earnings per share for the next year – so a discount to historic levels suggests investors can now pay less to buy into the same earnings growth potential. European small caps were second cheapest by historic standards (-19.8%) followed by Chinese large caps (-11.5%) and Japanese small caps (-8.8%). The UK and Japan are the only markets where both small caps and large caps have 12-month forward P/E ratios that are below their 10-year average.

Smaller companies (small caps) globally are trading at a discount: -3.2% compared to their 10-year average 12-month forward P/E ratio when looking at the MSCI All Country World Index (ACWI). But, at -23.4%, the discount for UK smaller companies is the biggest of any major index of small caps or large caps globally by a significant amount. This is despite the fact that UK smaller companies^[1] are forecast to grow their earnings by 10% over the next year (source: Factset as at 31/01/25). The companies in abrdn’s UK Smaller Companies Fund are forecast to grow their earnings by 19% on average over the same period while the FTSE 100 (an index of the UK’s largest companies) is only forecast to increase earnings by 4%.

Abby Glennie, co-manager of the abrdn UK Smaller Companies Fund and the abrdn UK Smaller Companies Growth Trust, said:

“These discounts reflect the negative sentiment that we’ve seen towards UK smaller companies in recent times. True it’s been a tough period for the sector – with weaker performance and tightening regulation. But ultimately negative sentiment is just that – sentiment. When you look at the fundamentals, there are many brilliant smaller companies in the UK who are outperforming global and much larger rivals in terms of earnings growth.

Investing in smaller companies can be volatile – but for those willing to take a long-term view, the current scale of discounts could present an attractive opportunity.”

The markets trading at the largest premiums to their averages over the past decade are Chinese small caps and US large caps (45.6% and 29% respectively).  In the US, this is likely down to high levels of investor confidence after a period of strong performance from American large caps. Chinese smaller companies are expensive versus historic levels because they have seen a material drop in earnings – therefore bringing down the E in the P/E ratio.

All data up to 31/01/2025. Source: Bloomberg

Abby Glennie added:

“For investors looking for diversification, an exposure to small caps could be very helpful. In recent years stock market performance has been dominated by the US and particularly the “Magnificent 7” tech companies. We see this reflected in the strong premium investors are willing to pay for US large caps – whose current 12-month forward P/E ratio is 29% higher than its 10-year average. However, there is increasing awareness that the narrowness of this outperformance is unhealthy and leaves the large cap benchmark subject to setback should any of these companies fail to deliver on investor expectations.

Performance among smaller companies is highly variable – some will flop, while others will grow into industry titans. This is why we take an active approach to stock picking, focusing on our investment process of “Quality, Growth, Momentum”. This means looking for smaller companies that are high quality, growing their earnings, and have good momentum behind them. Despite all the negative talk about the UK market, we are still finding plenty of exciting companies that fit this bill.”