There’s little denying it. FTSE 100 shares are cheap right now.
Since 1999, the index has gone up only 8.83%. That’s 24 years of growth that wouldn’t even keep up with a single year of modern-day inflation.
On a yearly basis, it works out to only 0.35%. It’s true that plenty of dividends have been paid out, so investors have made more than that. But just looking at the growth, that’s a shocking return.
The funny thing is: profits continue to grow. On a price-to-earnings (P/E) ratio, which tells us how costly stocks are relative to the profits they make, the FTSE seems to get cheaper and cheaper.
The forward P/E ratio now stands at just 10. A quick look across the Atlantic shows the S&P 500 has a forward P/E of over 20. Are we having a buy-one-get-one-free sale on stocks in this country? It feels like it.
So why are Footsie stocks so cheap? Well, as we might expect, it’s not a simple thing to explain. But I’d say there are three reasons for this underperformance.
First, the index has a lot of ‘old economy’ stocks. These are from industries like tobacco, mining or oil. A stock like Shell might be facing an eventual decline in its sales of oil. That brings the stock price down. Contrast this with an AI stock like Nvidia with a bright future. We pay a premium for that.
A second issue is Brexit. While UK stocks got a nice bump right after the vote, they’ve been sliding since then. Is it a case of the transition being poorly handled? It’s hard to say. Whatever it is, the FTSE 100 is still below where it was in 2017.
Bull market
A third issue is with the UK economy. There’s been a lack of growth since 2008 or so. Yes, it has grown since then, but that’s down to immigration. In per capita terms, our economy has stalled and that’s going to be less attractive to investors.
In spite of all this, I’m optimistic that a bull market is heading our way. And if it does, this might be an extremely rare, perhaps once-in-a-decade chance to pick up cheap stocks.
The reason is that profits are what drive a business. We can think of it like a beach ball. We can’t push one underwater without the air inside bringing it back up. Stocks work in a similar way. The FTSE 100 firms can’t continue increasing profits without the price going up to match it at some point. At least that’s what I think.
The forward P/E of 10 is cheaper than it’s been for over 10 years. The FTSE 100 cyclical adjusted P/E ratio (CAPE) – or a 10-year average P/E – is 16-17. A return to that level would be a 60% increase in prices.
3.8% yield
Also, dividends shouldn’t be overlooked. The current Footsie yield is around 3.8%, which means even in a year with no growth, I do get a decent return from my investments.
I’m fairly confident the Footsie will snap back at some point. It could take years. It could start shooting up tomorrow. Either way, I’ll keep buying high-quality FTSE 100 shares while they’re still cheap.
