In January I was firmly convinced that the FTSE 100 was on a bargain valuation at over 7,700 points, and I reckoned it still looked cheap compared to the world’s other top markets. And its average dividend yield was higher than it had been for years.
The UK’s top index has performed strongly over the past couple of years, with 2016 and 2017 having brought in total returns (including dividends) of 19% and 12% respectively. But that came after two years of losses, and we were looking at average returns over the four years of a little over 5% per year.
Since then we’ve seen the UK’s top index falling right back down again to under 7,200 points, to give up all its recent gains and sit at a level that’s a shade below the same point a year ago.
Don’t panic!
The trigger was a global panic which went round the world several times, with one flock of sheep taking up from where the previous flock left off as markets closed and opened in succession. And those who really don’t know any better have been horrified… “The stock market has lost how much?“
So do I think I got it wrong and the FTSE was overvalued? Certainly not. What I reckon I’m looking at is an investment bargain that has just become even cheaper, and that’s great news for long-term investors.
All we have to do is look at the longer-term FTSE 100 chart, and we see a meagre 13% gain over five years. That was boosted by dividends, but it’s still poor when compared to the index’s longer-term returns.
Uncertainty
Interestingly, though we’ve been through some hugely uncertain times when investors typically shun riskier shares and seek safer blue-chips, the FTSE 250 has come out well ahead over the past decade. The smaller-cap index is up more than 90%, compared to just 26% for the FTSE 100 — surely another sign that the big one is undervalued now.
Most people investing today have lived through worse. The banking crisis was only a few years ago, and the dotcom crash of 2000 still seems like yesterday to many of us older investors. What both of those did, as with every dip that’s come along, was provide us with another opportunity to buy shares in great companies at knock-down prices.
What’s a good measure of the FTSE 100’s valuation? With the index made up mostly of mature blue-chip companies that are paying regular dividends, its average yield is surely one useful measure. AJ Bell‘s quarterly Dividend Dashboard summarises dividend forecasts across the index, and the last one in December 2017 indicated an average yield of 4.3%.
Good value
That’s significantly ahead of the long-term average of around 3.4%, and since then it’s got even better. The FTSE 100 is now down 5.7% since the end of last year, and that pushes up the average dividend yield to a little over 4.5% (assuming no material degradation in forecasts).
I see the FTSE 100 as a very attractive income prospect right now — the best it’s been in years. If you buy now (perhaps via a low-cost index tracker), you should enjoy a far better income than you could get from a savings account.
And you can see any further recovery and subsequent gains as a bonus. The FTSE 100 may not be set to surge in the short term, but its long-term prospects are good.
