Are the share prices of FTSE 100 companies cheap?

FTSE 100 the stock has underperformed in recent years. Investors who bought a fund tracking the return of Britain’s blue-chip benchmark at the end of 1999 would only get a 14.2% return today, excluding dividends.

However, the FTSE 100’s defensive credentials were announced in 2022, a year marked by difficult trading conditions. It is the best major stock market index, as energy giants, defense stocks, and pharmaceutical companies make up its constituents.

So, are Footsie stocks undervalued today? Here I am.

low valuation

First, it’s important to note that not all FTSE 100 stocks are created equal. Therefore my preferred investment strategy is to carefully select stocks from the index I want to invest in, while still ensuring my portfolio is sufficiently diversified across companies and sectors to limit the risk of loss that comes with a narrow concentration.

When looking for shares to buy, I find it useful to look at the price-to-earnings ratio (P/E). This is a popular valuation metric that is a useful indicator of a company’s stock price, despite its shortcomings. For example, it does not provide information about the level of debt.

Some of the Footsie stocks look very good compared to the index average of around 14. Banking stocks for example Lloyds and Barclays have a P/E ratio of seven and six. At the other end of the spectrum, engineering companies Spirax-Sarco has a P/E ratio above 39.

Overall, many FTSE 100 valuations are lower than popular US stocks, eg Tesla and Nvidia. The stock’s P/E ratio is 56 and 130, respectively.

In short, large UK stocks look cheap, especially compared to many stateside companies. Although the FTSE 100 may not have technology stocks with future growth potential, it is a great place to look for investment opportunities.

Stock dividend

Importantly, share price appreciation is not the whole story of FTSE 100 companies. Dividends also play an important role. To illustrate this, by following the dividend reinvestment strategy, the index would have returned 94% between 1999 and 2018. Despite the drop in the index point level from 6,930 to 6,845 over the 19-year period.

The average dividend yield of the FTSE 100 is now 3.5% higher than that S&P 500 at 1.7%. Income generating companies are often stable, established businesses with a track record of being cash generative.

Some of the high-yielding dividend stocks in the index are included GSKwith 6.3% yield, and British American Tobacco, with a yield of more than 7%. Shareholder payouts are not guaranteed as dividends can be cut or suspended at any time, but again the FTSE 100 is a good place to start for investors looking for passive income.

Should I invest in FTSE 100 shares?

I already own some FTSE 100 stocks and I will continue to invest in UK stocks this year, along with overseas equities.

Global macroeconomic conditions could prove turbulent in 2023, as they did in 2022. Inflation rates remain high, fears of a recession are rising, and interest rates are rising. In that context, I think the FTSE 100 has a good chance of becoming the best index in the world.