While the FTSE 100 may have delivered an impressive return since the start of the year, gaining 7.5%, it continues to be grossly undervalued compared to the S&P 500.
In fact, the index trades only slightly higher than it did almost 20 years ago. While this may indicate that it was overvalued in 1999, its current valuation suggests it could offer significant growth over the long run.
Here’s why the index could more than double over the coming years, and how investors can capitalise on its potential growth rate.
While the last two decades have seen two major recessions, namely the dot com bubble and the financial crisis, major indices such as the S&P 500 have been able to generate impressive total returns.
For example, the S&P 500 has risen from around 1,300 points two decades ago to trade at around 2,800 points today. That’s an annualised return of 4%, excluding dividends, with the index enjoying strong gains since the end of the financial crisis as the impact of a loose monetary policy by the Federal Reserve pushed asset prices higher.
By contrast, the FTSE 100 has disappointed over the last two decades. It has risen from 6,350 points to just 7,250 points, which is an annualised return of 0.7%, excluding dividends. This indicates the index has failed to benefit to the same extent as its peers from the improving global economic performance over the last 20 years.
As a result of its disappointing performance, the FTSE 100 now appears to offer a wide margin of safety compared to the S&P 500. It has a dividend yield of 4.6% compared to a yield of 1.9% for the S&P 500.
This suggests it offers significantly better value for money, and that it could be grossly undervalued. If it was to trade on the same yield as its American counterpart, it would be on around 17,400 points.
While this price level is unlikely to be achieved over the next few years, it shows that over an extended time period the index could deliver capital growth after what has been a challenging period for large-cap UK investors.
Capitalising on the FTSE 100’s growth potential
For investors who wish to capitalise on the FTSE 100’s growth potential, buying units in a tracker fund could be a sound move. They provide reduced risk due to the limiting of company-specific risk, while also offering the potential for strong capital growth in the long run.
However, other investors may wish to focus on the FTSE 100 stocks with the lowest valuations, highest yields and best growth prospects. Over the long run they could offer even more appealing total returns than the wider index, with many of them being drawn to value, growth and income for investors alike. As such, now could be the right time to buy a range of them within a well-diversified portfolio.
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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.