Investing in the FTSE 100 index has traditionally been a popular choice for passive income seekers. However, in recent years, Britain’s leading benchmark has fallen out of favour.
That might be unsurprising considering the FTSE 100 trailed the S&P 500 by a significant margin over the past decade. While the Footsie advanced just 12% since January 2014, America’s flagship index delivered a 160% gain.
Nonetheless, despite its recent underperformance, I believe there are good reasons for dividend investors to give FTSE 100 shares serious consideration today. Here’s why.
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Cheap valuations
First, UK stocks look pretty cheap right now compared to their historical valuations.
Based on metrics such as price-to-earnings (P/E) ratios and price-to-book (P/B) ratios, FTSE 100 shares currently trade near the bottom of their 30-year range, let alone the past decade!
What’s more, compared to overseas stocks, the Footsie looks undervalued in relative terms. The below table neatly demonstrates this.
| Index | P/E ratio |
|---|---|
| S&P 500 | 23 |
| FTSE All-World | 16 |
| FTSE 100 | 9.5 |
High dividends
Second, a further standout feature of the FTSE 100 is the notable concentration of dividend heavyweights among its constituents. Currently, the index yields a healthy 3.8%.
Many Footsie companies are well-established businesses with long track records of profitability and delivering passive income. These include commodity giants, banks, insurance firms, and telecoms titans.
There’s an absence of tech stocks, which feature heavily among America’s largest companies measured by market cap. These companies often pay small dividends, or don’t provide any shareholder payouts at all.
Currently, the FTSE 100’s passive income prospects look particularly strong. Last year’s total of ordinary dividends, special dividends and share buybacks amounted to a whopping £137.2bn. Beaten only marginally by 2022’s record figure of £137.6bn, that equated to a chunky cash yield of 6.9%.
Individual stocks
Third, beyond the index as a whole, there’s merit in considering individual FTSE 100 stocks for a passive income portfolio too. A good example might be British American Tobacco (LSE:BATS).
The cigarette colossus currently trades near lows last seen in 2011. It also happens to be one of the Footsie’s leading dividend stars, boasting a mammoth 9.8% yield.
Granted, there are considerable risks that come with investing in ‘big tobacco’. Many analysts believe it’s a sunset industry and it’s no secret that governments around the world want to reduce smoking rates.
However, British American Tobacco is a cash-generating behemoth with a loyal customer base and a growing portfolio of ‘alternative’ nicotine products.
That’s enough to soothe my fears. The stock forms an important part of my passive income portfolio and I’m grateful for the bumper payouts I receive from my investment in the company.
Risk management
While I believe the case for considering FTSE 100 stocks as passive income investments is especially strong today, it’s essential to remember that dividends aren’t guaranteed and capital growth is important too.
Accordingly, I diversify my stock market investments across different geographies and sectors. I also hold fixed income assets, such as gilts, which help to reduce my portfolio’s volatility.
Having a credible risk management strategy in place gives me confidence to put my spare cash to work by loading up on cheap FTSE 100 dividend shares this year.
