Buy when the barbarians are at the gates
Buying when the price/earnings ratio is in single digits has usually been a good long-term bet
Buy when the barbarians are at the gates and sell when the trumpets sound the retreat.
At times when the euro seems to be falling apart, and the FTSE 100 is falling on a daily basis, it is worth bearing this old axiom in mind.
Let us start with absolute valuation measures. The FTSE All-Share is trading on a historic price/earnings (p/e) ratio of exactly 10 at the time of writing, and the FTSE 100 is on 9.2. Buying when the p/e ratio is in single digits has usually been a good long-term bet.
Of course, you can’t eat historic dividend yields. What matters is future income
Profits can be manipulated but dividends are normally paid in cash. The dividend yield on the All-Share is 3.8 per cent and it is 3.9 per cent on the FTSE 100. These are not spectacular numbers by historical standards. According to the Barclays Capital Equity Gilt-Study, the UK market yield was 4 per cent or higher in 75 of the first 92 years of the 20th century.
However, those are good yields by relative standards. The best savings accounts at the moment pay a little over 3 per cent. Ten year gilts yield just 1.8 per cent, and even if you take the leap and lend money to the British government for 30 years, your reward is just 3.1 per cent.
For those who fear inflation, the government won’t sell you index-linked national savings certificates at the moment, and the real yields on long-dated index-linked gilts are negative.
Of course, you can’t eat historic dividend yields. What matters is future income. There are times when the yield is high because profits are tumbling and investors expect dividends to be cut.
A sign of danger is when the cover ratio – the relationship of earnings to dividends – is low. But there is no danger signal at the moment. The cover ratio for the FTSE 100 is 2.76 and for the All-Share is 2.64. In other words, profits could halve and companies would still have enough cash to meet their payouts.
A further encouraging sign is that there are plenty of decent companies with dividend yields above 4 per cent. In the FTSE 100 alone (and this is not a recommendation for any individual stock), there is BAE Systems, HSBC, Standard Chartered, CRH, Reed Elsevier, BHP Billiton, BP, Royal Dutch Shell, GlaxoSmithKline, British Land, BT and National Grid, to name but a few.
One would expect a good equity income manager to pick a few bargains out of that lot. For the cost conscious, there is also the Vanguard FTSE UK Equity Income Index fund, which does what it says on the tin, owning roughly 120 stocks and operating with a total expense ratio of just 0.25 per cent. The stated minimum investment is £100,000 but one can buy a smaller holding through a Sipp.