The Income Investor: FTSE 100 retains income appeal despite record rally
As stock markets surge ahead, shares become more expensive and dividend yields decrease. But columnist Robert Stephens argues that the index is still undervalued and income investors can still obtain a very generous dividend yield.
by Robert Stephens from interactive investor
The FTSE 100’s surge to an all-time high may naturally prompt some income investors to question the appeal of large-cap shares. After all, the index’s rise means dividend yields will inevitably have been squeezed and market valuations will have expanded. This could equate to lower returns in future.
However, the index’s new record needs to be put into context, with its performance having been hugely disappointing from a share price perspective (excluding dividends) for the past 25 years. While the S&P 500 index has gained 256% since the turn of the century, the FTSE 100 index has risen by a paltry 20%. This equates to an annualised capital gain of just 0.8%. Although this figure does not include the impact of reinvested dividends, and therefore does not paint a full picture of the index’s true investment performance over recent years, it nevertheless highlights that many of its holdings are unlikely to be overvalued.
Indeed, the FTSE 100 index currently yields around 3.6%, even after surging by 13% over the past six months. By comparison, the S&P 500 index yields just 1.4%. This suggests that rather than now being ‘overvalued’, the FTSE 100 index’s constituents are more likely to have moved from being “grossly undervalued” to just plain “undervalued”. As such, income investors can still obtain a very generous dividend yield, both on a stand alone basis as well as relative to other stock market indices and asset classes, alongside income growth and further capital gains.


Source: Refinitiv as at 9 May 2024. Bond yields are distribution yields of selected Royal London active bond funds (end March 2024), except global infrastructure bond which is 12-month trailing yield for iShares Global Infras ETF USD Dist as at 7 May. SONIA reflects the average of interest rates that banks pay to borrow sterling overnight from each other (3 May). *Data prior to May is based on 3-month GBP LIBOR. Best accounts by moneyfactscompare.co.uk refer to Annual Equivalent Rate (AER) as at 8 May.
Dividend growth potential
An improving economic outlook is a key reason for the FTSE 100 index’s recent rally. Investors are looking ahead to a continued fall in inflation that will ultimately allow central banks to cut interest rates from their current multi-decade highs. While this process is arguably not progressing as quickly as many investors had hoped for, with inflation having been stickier than expected, it is nevertheless widely forecast to continue falling in the coming months.
Lower inflation that brings an end to the cost-of-living crisis and falling interest rates that encourage spending instead of saving among consumers, are likely to prompt improved operating conditions for FTSE 100 companies. This should equate to higher profits that allow them to increase dividends. Indeed, shareholder payouts are likely to rise at a significantly faster rate than inflation as the pace of price rises becomes far more in keeping with its historical average than has been the case over recent years
Monetary policy which becomes more accommodative in response to falling inflation is also likely to persuade investors to become less risk averse. It should prompt a much improved rate of economic growth that raises demand among investors for riskier assets such as equities. This could provide further capital gains for investors in FTSE 100 stocks, with the index having the potential to reach new highs alongside the provision of a generous and rising income in the years ahead.
A global outlook
With the FTSE 100 being a globally focused index due to over 75% of its members’ sales being generated from outside the UK, it offers a significant amount of geographic diversification that equates to reduced risk for investors. The index’s constituents should also benefit from central banks in the US and the eurozone being in a very similar position to their UK counterpart, in terms of inflation falling and interest rate cuts being on the near-term horizon.
Furthermore, the index contains a wide range of high-quality companies that have well-covered dividends, solid competitive positions and sound balance sheets. Their size and scale means they are less risky than smaller peers, while their low valuations mean they offer wide margins of safety.
Having been overlooked for over two decades, FTSE 100 stocks offer excellent value for money in many cases and still represent a significant long-term buying opportunity for income-seeking investors.
Robert Stephens is a freelance contributor and not a direct employee of interactive investor.
These articles are provided for information purposes only.
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