In a recent series of articles, I have been modelling the annual returns that may be available from a number of popular dividend-paying stocks, such as Marks & Spencer and Vodafone. However, for these forecasts to be meaningful, we need to know the expected return from the FTSE 100, which many investors use as a benchmark for their own portfolios.
The FTSE100 (FTSEINDICES: ^FTSE) currently offers a forecast yield of 3.1%; substantially less than the long-term average total return from UK equities, which is about 8%.
Total return is made up of dividend yield and share price growth combined — but can the FTSE add to the 11% rise it’s delivered so far this year?
What will FTSE’s total return be?
Looking ahead, I need to know the expected total return from the FTSE 100, in order to compare it to the expected performance of my portfolio.
The dividend discount model is a technique that’s widely used to value dividend-paying shares, but it can also be applied to an index, as long as the majority of the index’s members pay consistent dividends.
A variation of this model also allows you to calculate the expected rate of return on a dividend-paying share or index:
Total return = (Prospective dividend ÷ current share price) + expected dividend growth rate
Here’s how this formula looks for the FTSE 100:
(207.6 ÷ 6697) + 0.033 = 0.64 x 100 = 6.4%
My model suggests that the FTSE 100 could deliver a 6.4% annual return over the next few years, slightly below the long-term average return from UK equities of 8%. This suggests that the FTSE 100’s current valuation is slightly above average, but only by a small amount.
In my view, a 6.4% return is attractive, and the FTSE’s current valuation is close enough to average levels to make it a reasonably safe buy, at its current price.
Can we beat the FTSE?
As an active investor, I believe it’s possible to beat the 6.4% that’s on offer from the FTSE 100. My model suggests that a number of FTSE 100 stocks currently offer better returns than the index as a whole.
For example, my calculations suggest that Vodafone could deliver an annual return of 11.1% over the next few years, while Unilever may offer 10.6%, Aviva could generate 10.4%, and Royal Bank of Scotland Group could deliver a staggering 51% total return!