FTSE 100 hits record high – but British stocks are still cheap

Stock Market
Stock Market

The outlook for the UK economy may be gloomy, but investor confidence in the FTSE 100 is soaring.

The index of Britain's top 100 largest listed companies hit the 8,000 point mark for the first time ever today. Prior to 2023, the previous record high for the index was 7,903.50, set on May 22 2018.

As the FTSE 100 climbs higher, investors may be wondering if they will now have to pay a premium to buy UK stocks.

But just because the stock market is up does not mean it is more expensive than it used to be.

In fact Rupert Thompson of investment management firm Kingswood says the FTSE 100 is “considerably cheaper than normal” at the moment.

“The 12-month forward price-to-earnings ratio of 10.6 is currently some 32pc lower than that for the rest of the world, whereas the average discount over the last 30 years has been only 10pc,” he says. “It also looks cheap in absolute terms – its price-to-earnings ratio is currently some 25pc below the 30-year average level of 14.0x.”

Price-to-earnings or p/e ratios are a crude measure of how long it will take a company to pay back its market value. The lower the p/e, the “cheaper” a company is. However, there could be other reasons a p/e is low, which may also mean it is less of a bargain than it first appears.

A high price-to-earnings ratio means that investors are willing to pay more for the shares of the companies in the index, in the expectation that their future earnings will rise. At 11, the current ratio suggests the London stock market is at a substantial discount even by historical standards.

For years, the FTSE 100 has lagged behind its peers on the global stage, resulting in extremely cheap valuations.

Rob Burgeman of wealth manager RBC Brewin Dolphin says the London market's pedestrian long-term returns justifies its un-loved status.

He calculates that over the past five years, the FTSE 100 has returned 23.8pc when factoring in dividends – the equivalent of 4.37pc a year.

“Over the same period, the MSCI World [a measure of global stock markets] in sterling terms has risen by 60.63pc including dividends, which is an annual equivalent of 9.95pc,” he says.

Darius McDermott of the research firm FundCalibre adds: “Since Brexit, UK equities have been some of the least popular assets on the global stage. This long period of negative sentiment is why the FTSE 100 – which has risen on the back of a handful of its biggest stocks going up – is still cheap.”

Why is the FTSE back at record highs?

The index's long-term underperformance is down to the heavy weighting toward oil, mining and financial services stocks and its minimal exposure to the technology sectors that have driven global markets over the last decade. But last year the tide turned in favour of commodity-linked stocks (and away from the fast growing technology companies) and the FTSE 100 beat the broader MSCI World Index by 5.45 percentage points.

Thompson says he believes a similar trend will play out in 2023. “Whereas in recent years its bias towards the commodity sectors has been a negative for the UK market, we believe its tilt to these areas should stand it in good stead over the next year or two as commodity prices should remain well supported and these sectors remain cheap.”

Burgeman says higher inflation and rising interest rates have boosted the sectors that make up core components of the index. “A challenging economic environment has seen investors flock to more defensive sectors such as pharmaceuticals, tobacco and consumer staple stocks like Unilever and Reckitt Benckiser,” he says.

“This is not an environment that we particularly see changing for a while to come yet, so these sectors are likely to remain in demand.”

A cheap way to invest in the FTSE 100 is to buy a tracker fund, which will give you exposure to all the funds in the index. Alternatively, you could buy individual shares in the index. The tables above indicate which companies are the most and least popular among equity analysts right now.