COMMENT
Why The Market Is Still Cheap

It is highly unusual for the FTSE to dip below a P/E of 14, but last week it did just that. And apart from a brief time in April of this year, when the FTSE was valued at a P/E of 13.96, you need to go back to 1996 to find the last time that the UK market was valued this cheaply.

Such a P/E implies that investors are paying £14 for every pound of profit that UK companies make. By comparison, the interest on most savings accounts is around 5%. This means you will need to invest £20 to earn the same amount of interest.

So in terms of P/E, the UK stock market is ostensibly cheap. Measured on this basis, shares are slightly cheaper now than they were back in March 2003 when the index hit a low of 3,287. Although the FTSE 100 has risen by more than 60% in the last two and half years, company profits have actually increased by slightly more.

But that's not all. Currently, the dividend yield on the FTSE is 3.2%. This implies that investors are receiving £3.20 for every £100 they have invested in shares. Interestingly, the yield on shares has been considerably higher in the past, but after share buybacks are taken into account the income from UK shares looks very attractive. Many big companies have flagged up massive share buyback plans. These include BP (LSE: BP.), which intends to buy back £5.6b of shares, and Vodafone (LSE: VOD), which plans to repurchase £4.5b. Others include Shell (LSE: SHEL), which has earmarked £2.8b in share buybacks, and AstraZeneca (LSE: AZN) and GlaxoSmithKline (LSE: GSK), which plan to repurchase £1.7b and £1b of their own shares respectively.

Collectively, the share buybacks amount to over £15b, or 1.2% of the value of the UK's biggest companies. Adding this to the income from dividends effectively bolsters the total cash distribution by companies to over 4.4%. This compares favourably with yield you can get from government bonds, which is currently around 4.3%.

The cheapness of the UK market has been brought about largely by the low valuations of many of its main constituents. For instance, BP and Shell, which together account for almost 20% of the value of index, are only valued at 12 times earnings. Elsewhere, banks and miners are valued at 13 and 12 times earnings respectively.

What's more, UK companies look set to deliver higher earnings this year, with even bigger dividend payouts to match. This augurs well for the FTSE, and for those of us with index trackers!