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Is the FTSE 100 ‘overvalued’ at 7,600 points?

During the last few days of 2017, the FTSE 100 enjoyed a classic ‘Santa Rally’ and broke out to a new high. It trades at 7,650 points as I write.

So does the high level of the index mean that it’s overvalued at present? Is now the time to be avoiding shares, or could the index run higher in 2018? Let’s take a closer look at the current state of the FTSE 100. 

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Valuation

According to Stockopedia, its trailing P/E ratio at present is 18.8. The general rule of thumb with P/E ratios is that anything under 15 is considered cheap, while anything over 15 is expensive.

While the current ratio of 18.8 indicates that the index is not in bargain territory, it is also not too far above the long-run FTSE 100 average of around 15-17. This suggests to me that the index is not terribly overvalued at present.

It’s also worth noting that when compared to other global stock markets, the FTSE 100 does look attractively valued right now. For example, the trailing P/E ratio of the US’s S&P 500 index is currently around 26. So the FTSE 100 seems cheap in comparison.

Individual valuations

Individual valuations at the top of the index don’t look excessively high either.

For example, the FTSE 100’s largest stock, HSBC Holdings, currently has a P/E of 14.2 and a dividend yield of 5%. Similarly, Royal Dutch Shell has a P/E of 15.6 and a yield of 5.5%. Those metrics look very reasonable, in my view.

In contrast, if we look at top constituents of the S&P 500, Apple currently has a P/E ratio of 19 and a yield of 1.5%, while Amazon.com has a P/E of 300 and pays no dividend.

Furthermore, around 40% of the stocks in the FTSE 100 are currently 10% or more below their 52-week highs. For example, GlaxoSmithKline is 23% off its 52-week high. National Grid is 21% below its high. Barclays has fallen 17%. Even ever-popular Unilever is 11% off its 52-week high. This suggests to me that there’s little exuberance associated with UK stocks at the moment. 

Long-term laggard

The slow long-term progress of the FTSE 100 is also something to consider. Over the last 10 years, the index has risen a little over 20%. But the S&P 500 has surged over 90%.

After almost touching 7,000 points in 1999 and 2007, the index suffered dramatic pullbacks on both occasions, losing around 50% of its value. Is it finally time for a sustained run above 7,000 points?

Risks

Realistically, no one knows exactly how the FTSE 100 will perform going forward. While its valuation doesn’t look outrageous, plenty of risks remain.

Therefore, perhaps the most sensible investing strategy right now is to ‘average in’ to the stock market at regular intervals. Invest small amounts on a monthly or quarterly basis. This will ensure that you don’t invest a lump sum at the top of the market, only to see your capital plummet in value if markets pull back.

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Edward Sheldon owns shares in GlaxoSmithKline and Royal Dutch Shell B. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Amazon, GlaxoSmithKline, and Unilever. The Motley Fool UK has recommended Barclays, HSBC Holdings, and Royal Dutch Shell B. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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