Does The FTSE Pass My Triple Yield Investment Test?

Is the FTSE 100 (LON:UKX) still a buy in today’s market? Roland Head puts the index to the test.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Pound Coins

Like most private investors, I drip-feed money into my investment account each month. To stay invested, I need to make regular purchases, regardless of the market’s latest gyrations.

However, the FTSE 100 (FTSEINDICES: ^FTSE) is up 75% on its March 2009 low, and is no longer cheap.

So is the UK’s blue-chip index still a buy, or do investors need to look elsewhere?

The triple yield test

Low interest rates mean that the stock market has become a popular choice for investors who want their savings to stay ahead of inflation.

To gauge the affordability of the market, I like to look at three key yield figures — the trailing dividend and earnings yields, and the forecast yield for the year ahead. I call this my triple yield test:

FTSE 100 Value
Current price 6,650
Earnings yield 5.8%
Trailing twelve month dividend yield 2.9%
FTSE 100 forecast yield 3.2%
Instant access cash savings rate 1.5%
UK 10yr govt bond yield 2.7%

The earnings yield is simply the inverse of the P/E ratio, and the FTSE’s earnings yield of 5.8% equates to a fairly high P/E of 17.2

However, analysts are predicting average earnings per share growth of 9% for FTSE 100 constituents over the next year, placing the index on a forecast P/E of 14.7, which isn’t expensive.

Strong earnings growth is expected to fuel a continued rise in dividend payouts, and the index currently trades on a forecast yield of 3.2%, more than double the interest available from a decent instant access savings account, and 0.5% more than 10 year gilt bonds.

FTSE 100 vs. the rest

To put the FTSE 100’s valuation into context, it’s worth looking at the UK stock market as a whole.

2014 Forecast UK Stock
Market
FTSE 100
P/E ratio 14.6 14.7
Earnings per share growth 13.5% 9.0%
Dividend yield 2.7% 3.2%

The figures above show that the UK’s biggest companies are expected to stay true to form, delivering slower earnings growth but higher incomes for shareholders, even though the FTSE 100 forecast P/E is almost exactly the same as the average P/E for the wider UK stock market.

Is the FTSE 100 a buy?

In my view, FTSE 100 tracker and exchange traded funds, such as the iShares FTSE 100 ETF (LSE: ISF), continue to offer an attractive level of income, relative to small cap stocks and government bonds.

However, the FTSE currently trades on a multiple of more than 17 times its members’ trailing earnings. This isn’t cheap, but the index’s 2.9% yield is above the current 2.0% rate of inflation, and if earnings grow as forecast in 2014, today’s FTSE 100 ‘price’ of 6,650 won’t look expensive at all in a year’s time.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

> Roland does not own shares in the iShares FTSE 100 ETF or ITV.

More on Investing Articles

Illustration of flames over a black background
Investing Articles

2 red-hot UK growth stocks to consider buying in April

These two growth stocks are performing well, but can they continue to deliver for investors through 2024 and beyond?

Read more »

Charticle

Is JD Sports Fashion one of the FTSE 100’s best value stocks? Here’s what the charts say!

The JD Sports Fashion share price remains a wild ride during the first quarter. Could it be one of the…

Read more »

Investing Articles

Could the JD Sports Fashion share price double in the next five years?

The JD Sports Fashion share price has nearly halved in the past five years. Our writer thinks a proven business…

Read more »

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

If interest rate cuts are coming, I think these UK growth stocks could soar!

Falling interest could be great news for UK growth stocks, especially those that have been under the cosh recently. Paul…

Read more »

Investing Articles

Are these the best stocks to buy on the FTSE right now?

With the UK stock market on the way to hitting new highs, this Fool is considering which are the best…

Read more »

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Can the Centrica dividend keep on growing?

Christopher Ruane considers some positive factors that might see continued growth in the Centrica dividend -- as well as some…

Read more »

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

How I’d turn my £12,000 of savings into passive income of £1,275 a month

This Fool is considering a strategy that he believes can help him achieve a stable passive income stream with a…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »