As part of today’s special feature “Where Next for UK Equities?” investment and market experts are sharing their views on valuations, opportunities and what could drive the next phase for UK stocks. In the following analysis, one such expert, and that’s Eustace Santa Barbara, co-manager of the IFSL Marlborough Special Situations, UK Micro-Cap Growth and Nano-Cap Growth Funds, has been telling us why he believes that there are compelling opportunities to invest in the UK just now, with many stocks undervalued, and why the sector merits closer attention than it has done for many years.
I wonder what you would think if I were to say UK equities could handily outperform their US peers in the years ahead. Given that the exact opposite has been the case for some time, you might well infer I am somewhere between commendably optimistic and utterly deluded.
Hear me out, though. Fears that the fervour for artificial intelligence (AI) has stretched many company valuations to breaking point are growing, and the prospect of a bubble burst to rival that of the dot-com frenzy of the late 1990s and early 2000s is now reshaping the global investment narrative.
If AI really has sparked a dangerous bout of “irrational exuberance” – to use the term coined by Alan Greenspan, then Chairman of the Federal Reserve, in 1996 – we might reasonably expect the US to take the biggest hit. It is, after all, home to most of the world’s largest technology companies.
The wonders of the Cyclically Adjusted Price Earnings (CAPE) ratio help paint an instructive picture here. Devised by American economist Robert Shiller, the ratio aims to gauge whether a stock or a group of stocks is undervalued or overvalued by comparing its current market price to its previous 10 years of inflation-adjusted earnings.
The US’s CAPE ratio is higher now than it was both ahead the Wall Street crash of 1929 and during the go-go days of the Nifty Fifty in the 1960s. It stands at close to 40, a figure exceeded only in the run-up to the aforementioned dot-com debacle[1]. This indicates that many US equities are spectacularly overvalued.
By contrast, the UK’s CAPE ratio is beneath 20. This indicates that many UK stocks are significantly undervalued.
Of course, valuation is neither a timing mechanism nor a fool-proof basis for informed investment decisions – especially one that is backward-looking. But it is during periods like this that Warren Buffett’s “hamburger” analogy inexorably comes to mind.
Buffett famously asked Berkshire Hathaway’s shareholders if they would like hamburgers to be cheap or expensive. Logically, he said, they should prefer the former – so it ought to follow that they should also favour lower-priced stocks[2].
This was the Sage of Omaha’s way of highlighting the opportunities inherent in market downturns. In my view, not least against the present backdrop, the UK serves as a classic illustration of this phenomenon – particularly in the arena of smaller companies.
From headwinds to tailwinds
The UK’s small-cap and mid-cap companies have struggled to pique the wider investment community’s interest for some time. While part of the problem is that they are routinely under-researched, a number of negative dynamics have conspired against them.
The malaise arguably set in following the 2016 vote for Brexit, which seriously dented the UK’s appeal in many investors’ eyes. The COVID-19 pandemic brought further headwinds, and ongoing economic and political instability has done precious little to aid the cause since.
It would be rash, however, merely to assume every smaller company has suffered in the face of these pressures. Many have thrived, underlining that a business’s unique attributes – rather than sweeping generalisations derived from macro considerations – can often be the best guide to potential performance.
Speaking of which, it is invariably worth remembering that smaller companies have a record of outperforming their larger counterparts over the long term. Ultimately, they simply have greater capacity for growth. Even the US’s tech titans were relative tiddlers once upon a time.
Merger and acquisition levels in the UK are also encouraging. Uncertainty around tariffs stifled M&A activity in Q1 2025, but Q2 saw the highest volume of transactions in half a decade.
So far this year, across the UK market as a whole, the majority of M&A bids have been below £500 million – a further sign of the value on offer in the small-cap and mid-cap universe. Meanwhile, more UK businesses are engaging in share buybacks, showing they regard themselves as undervalued and have confidence in their financial health[3].
Curiously, despite claiming to have a pro-growth agenda, the government has yet to exhibit similarly unflinching faith in the lower end of the market-capitalisation spectrum. Its reluctance to enhance – or even raise awareness of – the attractions of an investment sphere expressly defined by the promise of growth is baffling, if not thoroughly exasperating.
Might the imminent Budget address this issue? Your guess is as good as mine. Frankly, I rather doubt it. Judging by the recent Pensions Scheme Bill’s abject failure to promote more investment in smaller companies, we would be unwise to hold our breath.
Yet prudent investors seldom need politicians to steer them this way or that. They can instead rely on the evidence all around them – and right now, in my opinion, the evidence increasingly suggests the UK merits much closer attention than it has received in many years. Watch this space.
Eustace Santa Barbara is co-manager of the IFSL Marlborough Special Situations, UK Micro-Cap Growth and Nano-Cap Growth Funds.
[1] See, for example, YCharts: “S&P 500 Shiller CAPE Ratio”, October 15 2025 – https://ycharts.com/indicators/cyclically_adjusted_pe_ratio.
[2] See, for example, Investopedia: “Would you pass Warren Buffett’s hamburger quiz?”, April 11 2025 – https://www.investopedia.com/warren-buffett-s-hamburger-quiz-11712560.
[3] See, for example, Financial Conduct Authority: “Share Buybacks in UK Listed Equities: Multi-Firm Review”, August 2025 – https://www.fca.org.uk/publication/multi-firm-reviews/share-buybacks-uk-listed-equities.pdf.
