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Are the share prices of FTSE 100 companies cheap?

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FTSE 100 shares have underperformed in recent years. Investors who purchased funds that track the returns of the UK’s blue-chip benchmark at the end of 1999 would only be sitting on a 14.2% gain today, excluding dividends.

However, the FTSE 100’s defensive credentials came to the fore in 2022, which was a year marked by difficult trading conditions. It was the best performing major stock market index, thanks to the energy giants, defence stocks, and pharmaceutical companies that make up its constituents.

So, are Footsie stocks undervalued today? Here’s my take.

Cheap valuations

First, it’s important to note that not all FTSE 100 stocks are equal. This is why my preferred investing strategy is to carefully select shares from the index that I want to invest in, while still ensuring my portfolio is sufficiently diversified across companies and sectors to limit the downside risks that come with narrow concentration.

When searching for shares to buy, I find it’s useful to look at price-to-earnings (P/E) ratios. This is a popular valuation metric that serves as a useful indicator for how cheap a company’s shares are, although it has deficiencies. For example, it gives no information about debt levels.

Some Footsie stocks look particularly good value compared to the index average of around 14. Banking stocks such as Lloyds and Barclays have P/E ratios of seven and six respectively. At the other end of the spectrum, engineering firm Spirax-Sarco has a P/E ratio above 39.

Overall, many FTSE 100 valuations are considerably lower than popular US stocks, such as Tesla and Nvidia. The P/E ratios of these shares are 56 and 130.

In short, UK large-cap shares look cheap on the whole, particularly in comparison to many companies stateside. Although the FTSE 100 might lack tech stocks with high future growth potential, it’s a good place to look for value investment opportunities.

Dividend stocks

Crucially, share price appreciation isn’t the whole story when it comes to FTSE 100 companies. Dividends also play a crucial role. To illustrate this, by following a dividend reinvestment strategy the index would have returned 94% between 1999 and 2018. That’s despite a decline in index point levels from 6,930 to 6,845 over the 19-year timeframe.

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

Some notable high-yielding dividend shares in the index include GSK, with a 6.3% yield, and British American Tobacco, with a yield over 7%. Shareholder payouts aren’t guaranteed as dividends can be cut or suspended at any time, but again the FTSE 100 is a good place to start for investors seeking passive income.

Should I invest in FTSE 100 shares?

I already own a number of FTSE 100 stocks and I’ll continue to invest in UK shares this year, in conjunction with overseas equities too.

Global macroeconomic conditions could prove turbulent in 2023, just as they were in 2022. Inflation rates remain high, recession fears are rising, and interest rates are climbing. In that context, I think the FTSE 100 stands a good chance of being the world’s top-performing index once again.

The post Are the share prices of FTSE 100 companies cheap? appeared first on The Motley Fool UK.

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Charlie Carman has positions in British American Tobacco P.l.c., Lloyds Banking Group Plc, Nvidia, and GSK. The Motley Fool UK has recommended Barclays Plc, British American Tobacco P.l.c., GSK, Lloyds Banking Group Plc, Nvidia, and Tesla. 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.