Where The Value Is In The FTSE 100 Today

The FTSE 100 (FTSEINDICES: ^FTSE) has been knocking on the door of 6,900 this year, but the door has yet to open. Is the market just too expensive?

The FTSE 100 certainly trades on a higher earnings multiple today (14.1x) than three years ago (11.4x). As we know, though, the index is the sum of its parts. Some parts are more expensive than others, and I’ve been digging down to look for where the value is today.

The table below shows the trailing price-to-earnings (P/E) ratios for the different FTSE sectors.

Telecommunications and Basic Materials leap out as areas in which we might potentially find good value. However, we can forget Telecommunications, because the trailing P/E is massively distorted by fundamental changes at sector giant Vodafone.

Miners

Within Basic Materials, the Mining sub-sector shows particular promise, because the P/E is just 8.1. Adding to the interest is a dividend yield that has risen to 3.4% from 1.4% three years ago.

For heavyweight value, I don’t think you need to look beyond top-ranked Footsie miner Rio Tinto (LSE: RIO).

Iron Ore is Rio’s main business, and over-supply and weak prices are weighing on analysts’ current-year earnings estimates. The consensus is for earnings per share (EPS) to decline around 5% this year, pushing the P/E up to 9.9 at a share price of 3,140p — still well below the market average.

Furthermore, with new management’s “relentless” focus on costs and capital discipline, and improvement in the group’s much-maligned aluminium business expected to start kicking in, the City experts reckon EPS will power back 15% next year, bringing the P/E down to 8.6. For good measure, dividend forecasts imply a yield of 4.3%.

Supermarkets

Another sub-sector with potential value is tucked away in the otherwise highly-rated Consumer Services sector. The Food & Drug Retailers sub-sector has a P/E of 11.2 compared with 14.2 three years ago, while the dividend yield has risen to 4.6% from 3.4%.

A glance at the P/Es of the seven companies the FTSE includes reveals the sub-sector’s lowly rating is due entirely to supermarkets Tesco (LSE: TSCO), J Sainsbury (LSE: SBRY) and Wm. Morrison Supermarkets (LSE: MRW).

As with Rio, forecast earnings declines this year raise the forward P/Es above the trailing number used by the FTSE actuaries. Furthermore, the earnings declines are more severe in the case of the supermarkets — Morrisons (48%), Tesco (16%) and Sainsbury’s (7%) — and forecast EPS recovery next year isn’t sufficient to give P/Es as low as Rio’s bargain-basement 8.6.

Nevertheless, the supermarkets’ P/Es — Tesco’s and Sainsbury’s at any rate — are firmly on the value side of the market average. The dividend yields are also very decent, albeit the payouts are covered less than twice by earnings, compared with Rio’s healthier 2.7 times.