Investing in UK dividend stocks is one of my favourite ways to earn passive income. The companies in the FTSE 100 and FTSE 250 often have higher yields than firms in overseas indexes, such as the S&P 500.
Following years of UK stock market turmoil, there’s a strong case to be made that British shares are undervalued today. Indeed, Apple‘s market capitalisation of $2.91trn is higher than the FTSE 100’s total market cap of $2.44trn. That’s a remarkable valuation gap.
Here’s why I think this could be a once-in-a-decade opportunity to buy cheap UK dividend shares.
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Cheap valuations
Price-to-earnings (P/E) ratios are a widely used metric to determine the relative valuations of stocks. Using them as a guide, UK shares trade at a significant discount compared to their international counterparts.
| Stock market index | P/E ratio |
|---|---|
| FTSE 100 | 8.7x |
| FTSE 250 | 11x |
| FTSE Emerging Index | 11.5x |
| FTSE Developed Europe Index | 12.5x |
| FTSE Japan Index | 13.9x |
| S&P 500 | 22.1x |
As the table above shows, the FTSE 100 and FTSE 250 are trading at multiples dwarfed by the S&P 500. Elsewhere, the differential isn’t quite as stark, but UK firms still look more attractively valued.
A narrowing gap?
There are signs the gulf in relative valuations between UK equities and the rest of the world could begin to close soon.
After all, the Footsie touched an all-time high earlier this year before the recent downturn. The more domestically-focused FTSE 250 is still considerably below its pandemic peak, but if the UK economy’s performance exceeds expectations, it could be primed for a rally.
In addition, the market currently expects the Bank of England will hike interest rates a further six times from here. That could lead to hot money flows into the UK, providing further momentum for sterling to appreciate.
In that context, future returns from pound-denominated assets could be more appealing than those offered by overseas stocks.
Big dividends
Beyond valuations, another attractive feature of London Stock Exchange-listed shares is the notable presence of high-yield stocks among their ranks.
To illustrate the point, here are the respective yields of the indexes we compared earlier.
| Stock market index | Dividend yield |
|---|---|
| FTSE 100 | 4.28% |
| FTSE 250 | 3.41% |
| FTSE Emerging Index | 3.36% |
| FTSE Developed Europe Index | 3.18% |
| FTSE Japan Index | 2.03% |
| S&P 500 | 1.34% |
So, not only do UK shares look cheap, but for investors like me who prioritise passive income, the regular payouts are higher than overseas stocks.
A rare chance to earn a second income
Overall, the UK stock market appears to be brimming with potential opportunities for dividend stock bargain-hunters.
That’s not to say there aren’t risks. The FTSE 100 and FTSE 250 are sometimes criticised for their lack of innovative firms. There’s a notable absence of exciting tech growth stocks compared to the US, for example.
Plus, dividends aren’t guaranteed. Several UK companies cut their dividends recently, including FTSE 100 energy stalwart SSE and FTSE 250 financial services outfit CMC Markets.
However, on balance, I think UK stocks have big passive income potential today. I’m looking close to home for my next portfolio additions while British equities trade at cheaper multiples, relative to their international rivals, than they have done in years.
