In recent months, stock markets have been on a roller coaster ride, from the April selloff to the May recovery. Despite the latest European market bounce, Morningstar metrics show that there are now more undervalued stocks than at the start of the year.
The Morningstar US Market Index had been on the verge of entering bear market territory following President Donald Trump’s announcement of reciprocal tariffs on April 2. The market then rebounded strongly from April 9 on the tariff pause, and then, on May 12, came news that the US and China had reached an agreement to temporarily reduce US tariffs on Chinese goods. The Morningstar Europe Index has outperformed the Morningstar US Market Index this year, but both US and European market slumps and rallies follow a similar shape.
After the Rally, There are More Undervalued Stocks
Looking at the 1,578 companies covered by Morningstar analysts, the percentage of stocks with 4 or 5 stars is currently 41%, while the percentage of those with 1 or 2 stars stands at 22%.
At the start of 2025, the percentage of undervalued stocks was 38.9%, and the percentage of overvalued stocks was as high as 23.9%, so the amount of undervalued stocks has increased and the amount of overvalued stocks has decreased.
A 4- or 5-star rating indicates that the stock is undervalued, while a 1- or 2-star rating shows that the stock is overvalued.
This may appear counterintuitive. But Michael Field, chief European market strategist, says that the answer lies with the nature of the latest rally.
“Yes, markets have rallied but some sectors have been left behind,” he says. Stock markets have become bifurcated by the impact of tariffs, and there may yet be worse to come, he adds.
He cites the examples of the energy sector, which is now screening as undervalued after the April 2 tariffs raised the prospect of a demand-sapping global recession.
The pharmaceutical sector is also suffering from weaker sentiment. As well as fears of new tariffs applicable to non-US firms, President Donald Trump has recently signed an executive order to lower prescription drug prices.
As of May 13, 11% of companies are significantly undervalued (5-star stocks) and only 5% are significantly overvalued (1-star stocks).
More European Stocks are Undervalued Than US Stocks
Where are the opportunities globally? Investors might think that as the US market has underperformed this year, the greatest opportunities must be there. But that is not the case. In fact, there are more opportunities in Europe than in the US. Morningstar metrics show that in Europe the percentage of cheaper stocks is at 57% compared with 39% in the US.
Morningstar’s Field says that there is still a “valuation gap” between the US and Europe, even as US economic growth slows and the eurozone lowers interest rates amid cooling inflation.
In terms of opportunities at a sector level, real estate and healthcare stand out, with 71% and 68% of stocks rated 4 or 5 stars, respectively. The financial sector, however, has the lowest percentage of cheap companies, at 24%.
How to Interpret the Morningstar Rating for Stocks
The Morningstar Rating for stocks is an analyst-driven measure of a stock’s current price relative to a Morningstar equity analyst’s estimate of what the shares are worth.
Stock star ratings indicate whether a stock is cheap, expensive, or fairly priced compared with the analyst’s assessment of its intrinsic value, or the fair value estimate.
Stocks trading at large discounts to their fair values receive the highest ratings (4 or 5 stars), while stocks trading at large premiums to their fair values receive lower ratings (1 or 2 stars). A 3-star rating means the current stock price is close to the analyst’s fair value estimate. The ratio of a stock’s price/fair value estimate that corresponds with each star rating is determined by its Uncertainty Rating:
5 stars (★★★★★): We believe appreciation beyond a fair risk-adjusted return is highly likely over a multiyear time frame. Our analysis indicates that the current market price represents an excessively pessimistic outlook, which limits downside risk and maximizes upside potential.
4 stars (★★★★): We believe appreciation beyond a fair risk-adjusted return is likely over a multiyear time frame.
3 stars (★★★): We believe investors are likely to receive a fair risk-adjusted return (approximately cost of equity).
2 stars (★★): We believe investors are likely to receive a less than fair risk-adjusted return.
1 star (★): We believe there is a high probability of undesirable risk-adjusted returns from the current market price over a multiyear time frame. Our analysis indicates that the market is pricing in an excessively optimistic outlook, which limits upside potential and leaves the investor exposed to capital loss.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
