Edinburgh-headquartered investment manager abrdn releases new research looking at how UK smaller companies fare in the world.

UK smaller companies are the most unloved and undervalued stocks in the world, according to new research by abrdn. This suggests that investors can pay less now than they have done previously in order to gain access to the same earnings potential. 

Comparing MSCI indices, abrdn found that UK smaller companies (small caps) are the most undervalued stocks in the world when looking at current 12-month forward P/E ratios (a metric investors used for valuing a stock or index) versus the 10-year average. It found that UK small caps are currently trading at a discount of -23.4 per cent to their 10-year average (data up to 31 January 2025). This is the widest gap of any major region.

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 that investors can now pay less to buy into the same earnings growth potential. European small caps were the second cheapest by historic standards (-19.8 per cent) followed by Chinese large caps (-11.5 per cent) and Japanese small caps (-8.8 per cent), the research showed. 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.

Small caps globally are trading at a discount of -3.2 per cent compared with their 10-year average 12-month forward P/E ratio when looking at the MSCI All Country World Index (ACWI). But, at -23.4 per cent, 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 are forecast to grow their earnings by 10 per cent over the next year, the firm said in a statement.

Dan Brocklebank at Bermuda-based Orbis Investments also recently underlined the case for investing in the UK, saying it is an undervalued market. The firm favours UK mid-small caps. Brocklebank is overweight in the UK and underweight in the US.

The companies in abrdn’s UK Smaller Companies Fund are forecast to grow their earnings by 19 per cent 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 per cent, the firm continued.

“These discounts reflect the negative sentiment that we’ve seen towards UK smaller companies in recent times,” Abby Glennie, co-manager of the abrdn UK Smaller Companies Fund and the abrdn UK Smaller Companies Growth Trust, said. “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,” she added.

The markets trading at the largest premiums to their averages over the past decade are Chinese small caps and US large caps (45.6 per cent and 29 per cent respectively), according to abrdn. In the US, this is likely to be 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,” the firm said.

“For investors looking for diversification, an exposure to small caps could be very helpful,” Glennie continued. “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.” 

abrdn is a global investment company that manages and administers £511.4 billion ($650 billion) worth of assets for clients.