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Should You Be Scared Of An Overheating FTSE 100?

Nobody’s ever happy, are they? When the FTSE 100 was in a slump, all the talking heads were fretting about how much lower it could get (while the smart investors were loading up on cheap shares).

Today the UK’s top index has doubled since its 2009 low point (though it still can’t hold above the 7,000 level) and every time I read a newspaper I see everyone’s worried that things are getting too hot and there’s going to be a correction.

But is there any substance to the latest fears?

Can’t stand the heat?

Well, for starters, the FTSE being up around a 15-year high is nothing to worry about. Stock markets have been growing in value for more than a century, and if we put aside the short-term ups and downs and plot a line from 100 years ago to today — it’s no surprise that we’d see a new all-time high every single day!

The other thing is that the FTSE 100 doesn’t actually exist, not in any meaningful sense anyway. It is literally nothing more than the sum of its parts, and we should be searching for the parts that are good value while ignoring the rest. In this case, it’s the trees that matter, not the wood.

So if you like the look of National Grid shares at 922p and fancy taking home a juicy dividend of around 5% per year, why does the level of the FTSE matter? The simple answer is that it doesn’t — what matters is how you rate the value of National Grid itself, not the share prices of the other 99 companies in the index.

And there are plenty of great dividends still to be had. At a price of 1,977p Royal Dutch Shell is forecast to yield more than 6% this year, with BP‘s 455p shares only a little behind on 5.5%. Similarly, GlaxoSmithKline at 1,442p is expected to yield 5.9%, with depressed miner BHP Billiton (1,380p) on a mooted yield of 5.7%.

Actually getting cheaper!

What’s more, in almost every case those dividend yields are higher than they were five years ago. On that measure, these shares are actually cheaper now than they were back then! And over the next decade or two, the chance that you’ll get nice capital growth too must be very high.

What if capital growth is your priority? ARM Holdings is the obvious FTSE 100 candidate, and its shares have soared by 350% in the past five years to 1,139p and on to a forward P/E multiple of about 35. Whether you think ARM is good value today depends solely on its own share price and how it compares with expectations for the company itself — and the share prices of the other 99 matter not a jot.

Now, if you’re buying the market or considering where different asset classes are going in the short term, growing negative sentiment could well send the FTSE into a correction as institutional investors feed off their own worries and withdraw some cash over the next couple of years. But such things are notoriously difficult to time, and tend to happen when people aren’t expecting them.

Good companies are the winners

If, instead, you ignore the index and focus on good companies at a fair-value prices, there are plenty of good candidates — and where a made-up number will go tomorrow or next week just isn’t a part of it.

That kind of calm long-term strategy can bring great long-term rewards.

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Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has recommended ARM Holdings and GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.