The underperformance of European equities compared to U.S. equities reached unprecedented levels in 2024. This divergence has widened the valuation gap between the United States and Europe. While the relative scarcity of tech companies listed in Europe is often cited as a reason, other explanations also account for this undervaluation.
Firstly, Europe was hit harder than the U.S. during the Global Financial Crisis, largely because the main export product of the United States at the start of the 21st century consisted of American mortgage loans. Additionally, the introduction of the euro contributed to lower valuations in the fragmented European markets. Following the euro crisis, European stocks denominated in dollars became significantly cheaper. The same trend applies to the impact of Brexit, with British equities being particularly undervalued even within Europe.
The war on the European continent has further exacerbated the situation, although an end to the conflict now seems in sight. One consequence of the war has been significantly higher energy costs in Europe compared to the rest of the world. Moreover, Europe’s growth has been stifled by an exceedingly expensive energy transition.
When companies are undervalued, they become more attractive to private equity and other firms seeking acquisitions. U.S. companies have the advantage of a relatively strong dollar compared to the euro. Additionally, U.S. companies are valued more highly due to their superior profitability, bolstered by higher profit margins.
Another factor is that U.S. companies pay significantly less tax than their European counterparts. In Europe, it is common for windfall profits—such as those earned by oil companies and banks—to be subject to additional taxes. Even though the legal basis for these extra fiscal levies is often tenuous, compliance is expected. Such measures are unthinkable in the United States.
Next week marks the start of Donald Trump’s presidency. Under Trump, taxes will be further reduced, and there will be significant deregulation. This includes U.S. regulators being less likely to oppose mergers and acquisitions.
In recent years, several deals have been blocked due to concerns about excessive market dominance or other potential consumer disadvantages. Under Trump, mergers and acquisitions will face fewer obstacles. It is logical for U.S. companies to leverage their higher valuations and the relatively strong dollar to seek inexpensive acquisitions in Europe.
Last year already saw increased private equity activity in European markets. The number of deals exceeding 1 billion dollar in value grew twice as fast in Europe as in other regions. The total value of these deals reached 133 billion dollar, a 78 percent increase compared to 2023. Politically and legally stable countries like the United Kingdom, Germany, and other Northern European nations were particularly attractive.
A part of this trend involves European companies relocating and possibly listing elsewhere. This alone can add value for shareholders. Any biotech company switching from a European listing to the Nasdaq, for instance, almost automatically receives a higher valuation. Similarly, oil companies in the U.S. are valued at twice the level of their European counterparts. In theory, this could mean that Royal Dutch Shell’s share price might double simply by obtaining a primary listing on the NYSE.
One of Europe’s largest banks, BNP Paribas, has 2.6 trillion dollar in assets compared to 4 trillion dollar for JPMorgan. BNP Paribas achieves a return on equity of approximately 12 percent, versus 15 percent for JPMorgan. Yet BNP Paribas is valued at 70 billion dollar, while JPMorgan commands a valuation ten times higher. BNP Paribas trades at six times earnings and 60 percent of book value, while JPMorgan trades at 14 times earnings and twice its book value.
France is a unique case within Europe. The country seems intent on stifling business activity, yet some of Europe’s most prestigious companies are headquartered there. Furthermore, the fragmented European automotive industry is likely to see a wave of consolidation in response to intensifying competition from Chinese manufacturers.
Europe also sees far more deals under 1 billion dollar than other regions. This is partly due to the highly fragmented buyout market in Europe. Even companies with strong market positions often remain under the radar, allowing acquirers to benefit from the “European discount”. This is particularly advantageous for consolidating private equity firms.
The discount for European companies increased further last year due to unrest in France and Germany and the impending Trump presidency. The relatively open European economy fears an imminent trade war with Trump, though Europe’s competitive position relative to China might improve due to much higher tariffs imposed on Chinese goods.
It seems inevitable that U.S. companies will go bargain hunting in Europe. Compared to the U.S., the market potential in Europe is at least equally large, valuations are favourable, and it offers U.S. firms access to innovative companies within a stable regulatory environment. Such a combination can foster mutual growth, benefiting the global economy. It reinforces the trend of multinational companies improving their competitive positions.
As the world becomes increasingly interconnected, a combination of American and European companies is better positioned for success. While an underweight position in European equities remains justifiable based on the developments of the past decade, the extreme valuation gap is likely to reverse eventually. Trump’s aggressive policies may create an appealing entry point for investors.
Han Dieperink is Chief Investment Officer at Auréus Wealth Management. He previously held CIO roles at Rabobank and Schretlen & Co.