In the second half of 2021, I repeatedly warned that financial assets had become an ‘everything bubble’ that was doomed to burst. And so it came to be. But during that time, I also wrote that UK shares — and especially FTSE 100 stocks — looked incredibly cheap.
UK shares stage a comeback
While global stock markets crashed last year, the FTSE 100 was a safe port in this storm. Indeed, the index actually rose by 0.9% in 2022. Adding in, say, another 4% for cash dividends took the Footsie’s yearly return to nearly 5%. This made it the best performer among major market indexes last year.
For me, the reason for this global outperformance was that UK shares were simply far too cheap. Yet even after recent rises, London-listed stocks still look dirt cheap to me. Here are three reasons why.
1. FTSE 100 earnings are modestly rated
In both global and geographical terms, the FTSE 100 looks mispriced to me. On a forward-looking basis, it trades at under 12 times earnings. This gives the index an earnings yield of 8.3%.
Meanwhile, the US S&P 500 index trades on a forward rating of nearly 18 times earnings. This translates into an earnings yield of 5.6% a year.
Thus, UK shares look a lot cheaper than US stocks. But history suggests that US shares garner higher ratings because of their superior earnings growth. Despite this, the FTSE 100 still appears inexpensive to me.
2. UK shares offer attractive cash dividends
As a dividend investor, I enjoy sifting through the FTSE 100 for income-generating shares. Helpfully, almost all Footsie firms pay cash dividends to their shareholders.
At present, the UK’s blue-chip index offers a forward dividend yield of 4% a year. To me, that’s a pretty decent ongoing return for taking on the risk of investing in company shares.
Meanwhile, on the other side of the Atlantic, the S&P 500 offers a cash yield of a mere 1.7% a year. However, US corporations generally prefer to reinvest their earnings into their businesses, rather than paying out cash to their owners.
Nevertheless, I like the balance and ballast that the FTSE 100’s market-leading dividend yield provides for my family portfolio. But as a value, dividend and income investor, I may be somewhat biased!
3. Cheap takeover targets
In 2022-23, UK companies increasingly became the targets of cash-rich bidders. Indeed, no fewer than 49 London-listed companies were subject to takeover bids last year, according to one UK investment platform.
Just this week, John Wood Group — a leading FTSE 250 oilfield-services company — admitted to turning down three cash bids from a US private-equity giant. Its shares soared by 28% on Thursday, after this news broke.
With US private-equity Goliaths sitting on huge amounts of uninvested cash, I expect more takeover activity this year among FTSE 100 and FTSE 250 firms. Also, the pound’s weakness against the US dollar makes our listed companies looks crazily cheap to American buyers.
In summary, with the FTSE 100 today trading at a 15% discount to global stocks, I’m still a fan of cheap UK shares. And that’s despite my growing worries about sky-high inflation, rising interest rates and a possible prolonged recession!
