COMMENT
Blue Chips To Beat Mid Caps

By Maynard Paton (TMFMayn)
December 20, 2005

The market hit a new all-time high yesterday. The market for mid-cap shares, that is.

In the last few years, the FTSE 250 index has outrun its FTSE 100 cousin by some distance. From the bear-market low of March 2003, the mid-cap index has rallied 126% while the blue-chip index has improved 69%. In fact, the FTSE 250 is now about 20% higher than the peak it recorded during the 2000 dotcom boom, while the FTSE 100 still languishes 20% below its record high. These articles try to explain the outperformance.

But can the mid-cap benchmark continue to beat the blue chips? On valuation grounds, I'd say the FTSE 100 looks the favourite from here.

This is how the FTSE 100 and 250 indices were valued at last night's close:

Index	Value	P/E	Yield (%)
FTSE 100	5,540	13.78	3.14
FTSE 250	8,594	19.34	2.36

Essentially, investors are currently prepared to pay 40% more for mid-cap earnings over blue-chip earnings (presumably because mid-cap earnings are expected to grow at a faster rate). Investors are also demanding a one-third greater dividend yield (presumably to compensate for slower blue-chip growth).

Let's put yesterday's P/E and yield ratings into perspective.

This table summarises the average P/E carried by the 100 and 250 indices since 1993:

Year	FTSE 100 P/E	FTSE 250 P/E	FTSE 250 P/E premium
1994	17.56	21.41	22%
1995	15.26	19.17	26%
1996	15.13	21.83	44%
1997	17.57	21.94	26%
1998	21.32	19.01	(11%)
1999	27.36	19.99	(27%)
2000	27.22	20.83	(23%)
2001	20.89	19.39	(7%)
2002	19.81	22.49	13%
2003	17.04	19.62	15%
2004	16.10	19.45	21%
2005*	14.52	18.66	29%

(* to 19 December)

Although the blue-chip P/E has decreased significantly over the last few years, it is not yet into unchartered territory in relation to the mid-cap P/E. Indeed, the mid-cap P/E has traded in excess of the current 40% premium during August/September 2004 and during January/February 2003. Given the mid-cap index has raced ahead since these dates, I think it's fair to say the relative P/E valuations do not indicate a screaming FTSE 100 'buy' at present.

However, the yield comparison is far more clear. This table summarises the average yield available from the 100 and 250 indices since 1993:

Year	FTSE 100 yield (%)	FTSE 250 yield (%)	FTSE 100 yield premium
1993	3.97	3.75	6%
1994	3.95	3.37	17%
1995	4.13	3.58	15%
1996	3.97	3.47	14%
1997	3.46	3.54	(2%)
1998	2.91	3.29	(11%)
1999	2.32	2.81	(17%)
2000	2.09	2.50	(16%)
2001	2.47	2.83	(13%)
2002	3.08	3.15	(2%)
2003	3.50	3.21	11%
2004	3.24	2.71	20%
2005*	3.19	2.57	24%

(* to 19 December)

Since 1993, the only time the blue-chip has yielded last night's 33% premium to the mid-cap yield has occurred in December 2005. On this basis at least, the FTSE 100 index appears much better value than its mid-cap cousin.

Of course, there are other factors to consider aside from valuation when comparing the two indices. For instance, how will the global earnings of the FTSE 100 compare in future to the largely UK-generated profits of the FTSE 250? And will the mainstays of the blue-chip index -- oil, banks, pharmaceuticals and telecoms -- outperform the numerous sectors that represent the mid-cap benchmark? Difficult to answer, really. But as I say, on valuation grounds at least, the FTSE 100 seems to me to be the favourite from here.

Disclosure: Maynard owns iShares FTSE 100, an exchange-traded fund that tracks the FTSE 100, and contributes regularly to a FTSE 100 index tracker.