Value Fund Manager and Research Analyst, Tom Grady at Schroders, assesses whether UK equities are fundamentally cheap relative to both history and their international peers.
Few would deny the UK market today looks cheap, yet ‘cheap’ comes in two shades. There is ‘cheap for a reason’ – also known as the ‘value trap’ – and then there is ‘good-value cheap’, which is the end-goal of the value investor. So which one is the UK? Here, we explore five valuation perspectives on whether UK equities offer good value relative to history and their international peers.
1. Repricing indices for money supply shows UK equities still below peaks
The narrative that markets are near all-time highs may be pervasive across the media but is it strictly true? Over time, asset prices generally appear to increase but that is because money is constantly being created – in other words, it is actually money that is being devalued rather than asset prices increasing. As such, before making a judgement on whether equity prices really are at all-time highs, we should first adjust for that important point.
The following chart shows the FTSE All-Share and S&P500 indices repriced as if the money supply in the UK and the US, respectively, had been held constant at 1982 levels. On this basis, while the S&P500 is indeed not far off the all-time highs it saw at the peak of the dotcom bubble at the turn of the century, the FTSE All-Share is a massive 60% below its own peak from around that time.
This adjustment matters because it takes account of the amount of wealth being directed towards domestic equity markets. Mathematically, that cannot grow forever – an economy needs to consume as well as save – and, similarly, it cannot go to zero because people need to save for retirement. It follows, therefore, that the further the gap grows, the more likely it is it will narrow – and the gap is now near the widest it has been in 40 years.
2. Valuation multiples suggest the UK trades at a historical discount
The UK also looks cheap relative to its earnings, equity and dividends. Our next chart shows the discount of the MSCI UK index compared with the MSCI World index on an average price/earnings (PE) ratio, price-to-book ratio and dividend yield. For most of the 40-year history, the MSCI UK has traded at around a 20% discount to its global (and increasingly US-weighted) equivalent. More recently, however, that has widened out to 40%.
So is this – as some commentators claim – effectively due to the FTSE All-Share being weighted towards banks, oil stocks and miners? That is not what the data shows. The following chart sets out the current PE ratio for each sector in the FTSE All-Share and S&P500 and the premium/(discount) of the FTSE All-Share versus the S&P500 – and the UK is cheaper across every sector. For the record, the average discount is 30%.
3. While a profitability gap exists between UK and US, there is significant overlap in the distributions
Now, this undervaluation could be explained if the profitability or growth of UK firms were lower compared with US companies so our next chart considers the distribution of return on equity (ROE) for companies in the FTSE All-Share compared with those in the S&P500. As you can see, some US companies do enjoy exceptional growth and profitability, but the majority of firms in both markets operate within a similar performance range. This overlap weakens the case that performance alone justifies the UK’s valuation discount.
4. Price-to-book vs ROE shows higher implied returns in the UK
To explore this idea further, our next chart shows the relationship between the price-to-book ratio and the ROE for each company in the FTSE All-Share and the S&P500. In general, there is a reasonably consistent relationship between the two metrics because, the higher a company’s ROE, the higher the multiple of the equity value the market should be willing to pay to achieve market-level returns.
If, for example, a company is earning 20% ROE but the market is willing to accept 10%, the market should be willing to pay twice the value of the company’s equity. If the company delivers 30%, the market should be willing to pay three times the value of equity. We can therefore use this relationship to test how cheap or expensive a market is relative to the returns of the companies within that market.
This is what the following chart illustrates. The implied equity returns on this basis are 5% for the US and 7.4% for the UK, meaning investors should receive 2.4 percentage points of higher returns per year in the UK compared with the US – and even adjusting for difference in quality!
5. Dividend yield spread adds support to UK investment case
It is probably no coincidence this number is similar to the premium you enjoy on dividends from the FTSE All-Share versus the S&P500. Real total shareholder return is ultimately the cumulative cash received relative to the price paid, which is why dividend yield can be used as an indication of prospective real total shareholder return – although you should never, of course, rely on a single year’s dividend to judge the value of a company.
That said, at the index level, the metric can offer an indication of the relative cheapness of two markets – for example, the FTSE All-Share’s dividend yield is currently 3.6% versus the S&P500’s 1.6%. Dividend growth does matter but, assuming the difference in growth between the UK and the US has not changed dramatically, the dividend yield can then be used to compare the relative cheapness of the two markets over time.
Our final chart therefore shows how the spread in dividend yield has changed between 2010 and 2025. The current difference is more than one-third higher than it was pre-Covid – even after the strong performance the FTSE All-Share has shown over the year to date. Indeed, to return to pre-Covid levels, the FTSE All-Share would need to rise almost 40%.
Taken together, these five different ways of looking at valuation all suggest the FTSE All-Share is cheap, both versus history and compared with the S&P500 – and even after adjusting for differences in index composition and the returns of underlying companies. While it is unclear what event could trigger a meaningful revaluation of UK equities, several forces could contribute – from improving investor sentiment to rising dividends. Given the consistent undervaluation across multiple metrics, the case for UK equities looks increasingly compelling.
