If you’re considering investing some of your money in the FTSE 100 (FTSEINDICES: ^FTSE), via a tracker fund such as the iShares FTSE 100 (LSE: ISF), then you will probably be hoping for some capital gains, along with a reliable dividend income.
Before buying, you need to ask: is the index expensive, how much income will you receive, and will that income keep pace with inflation?
To answer these questions, I’ve taken a closer look at the current valuation of the FTSE 100.
1. P/E
The FTSE 100 currently trades on a P/E ratio of 13.8, which is pretty average, historically, and is a reasonable level to buy at.
Although the index has risen by 78% from its low of 3,530 in March 2009, it’s worth emphasising how cheap shares were back then: many investors genuinely believed that the whole financial system was in danger of collapse.
As a result, although investors who bought into the market in 2009 did very well, there is still plenty of opportunity for today’s new investors to earn decent returns in more normal times.
2. Dividend yield
The FTSE 100 currently offers a dividend yield of 3.5%, which is far higher than that available from government bonds, or cash savings.
Although a number of FTSE 100 companies offer reliable yields that are considerably higher than 3.5%, the income from a single company cannot ever be as secure as the income from a large-cap index such as the FTSE 100, which is made up of around a 100 different companies, most of which contribute to the ‘FTSE 100 dividend’.
3. Dividend cover
The safety of a company’s dividend is traditionally judged by how many times it is covered by earnings per share, with most investors looking for a cover level of around 2. If cover falls too far below 2, the risk that the company will be forced to freeze, or even cut its dividend starts to rise.
Dividend cover can also be calculated for the FTSE 100 as a whole, and the current level of dividend cover for the FTSE 100 is 2.1, which looks pretty safe to me.
Beating the FTSE
Overall, I’d say that the FTSE 100 is a pretty safe buy at the moment, and should deliver respectable returns.
However, you may also want to spice up your portfolio with a few shares that have the potential to outperform the index, boosting your returns.