Over the last five years, the FTSE 100 has underperformed other major stock market indexes such as the S&P 500 and the MSCI All-Country World index by a significant margin. As a result, many investors currently believe that the blue-chip index is ‘cheap’ or ‘undervalued’ compared to other indexes.
Is that actually the case though? Let’s take a closer look at the valuation of the UK’s main stock market index.
Low valuation and high yield
If you’re just looking at basic valuation metrics such as P/E ratio and dividend yield, then the FTSE 100 certainly does look cheap compared to other indexes.
For example, the FTSE 100 currently has a median trailing P/E ratio of 17 according to data from Stockopedia. By contrast, the S&P 500 has a median trailing P/E of 22.3 while Canada’s S&P/TSX Composite index has a P/E of 18.6. Meanwhile, France’s CAC 40 has a median trailing P/E of 18.4.
It’s a similar situation with dividend yield, which is another key indicator of value. Currently, the FTSE 100 has a median trailing yield of 3.1%. In comparison, the S&P 500 has a median trailing yield of 2.1%, while the CAC 40 sports a trailing yield of 2.8% and Germany’s DAX has a yield of 2.5%.
Going on these metrics alone, the FTSE 100 definitely looks undervalued relative to other indexes.
Looking under the bonnet
Before you rush out and buy a FTSE 100 tracker fund to take advantage of the index’s bargain valuation, it’s worth stopping to consider why it is cheap and what you could do to boost your returns as an alternative. One reason the index has lagged others in recent years is that many of the companies at the top of the FTSE 100 (with the largest weightings) are struggling to generate growth.
The largest company in the FTSE 100, Royal Dutch Shell has seen its revenue fall by nearly 20% over the last five years. Meanwhile, the second-largest company in the index, HSBC Holdings, failed to generate any revenue growth between 2013 and 2018. The third-largest holding in the Footsie, Unilever, has done better, registering total revenue growth of 7% between 2014 and 2019, yet that’s not exactly a level of growth to get excited about. Of the three companies, Unilever is the only one that has increased its dividend payout in the last three years.
Look at the S&P 500, however, and it’s a completely different story. Here, the top three holdings have all enjoyed strong growth in recent years. For example, the largest holding in the index, Microsoft, has generated five-year revenue growth of 45% while Apple, the second-largest holding, has delivered five-year revenue growth of 42%. Meanwhile, the third-largest holding, Amazon, has generated top-line growth of a very impressive 215%.
So, while the FTSE 100 appears cheap and rewarding at first glance, perhaps it isn’t so cheap after all. Looking at the top-line growth of its largest holdings, there appears to be a good reason it trades at a lower valuation than other major indexes at present.
That said, looking at individual companies in the FTSE 100, there are certainly quite a few high-quality companies that do look cheap at the moment, in my view. If you’re looking for undervalued stocks, there are plenty of opportunities on offer right now. I particularly like Prudential, DS Smith and Legal & General.
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Edward Sheldon owns shares in Royal Dutch Shell, Unilever, GlaxoSmithKline, Diageo, Prudential, DS Smith, Legal & General Group, Apple, and Microsoft. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Amazon, Apple, GlaxoSmithKline, Microsoft, and Unilever. The Motley Fool UK has recommended AstraZeneca, Diageo, and HSBC Holdings and recommends the following options: long January 2021 $85 calls on Microsoft and short January 2021 $115 calls on Microsoft. 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.