FTSE 100 vs Dow Jones: why the 20% discount?
Dow Jones Industrial Average fans might not like the reminder that US blue-chip shares donât come cheap. Even with both markets climbing towards fresh highs, the FTSE 100 Index still looks cheaper on earnings, and more generous on income.
Both markets are near record highs
On 18 February, the Footsie rose 1.2% to end the day at 10,686 while the Dow also gained 0.3% to sit at 49,662. We can see the recent strong gains in both the iShares Dow Jones Industrial Average ETF (LSE: CIND) and iShares FTSE 100 UCITS ETF (LSE: ISF).
With both indexes rising, itâs tempting to compare them on a head-to-head basis. But I find looking just at the level of an index can be a distraction. The useful question is what investors are paying for earnings, and what theyâre getting back in cash in both markets.
Valuation
On paper, there are big ticks for the Footsie over its US index counterpart. The Dow has a price-to-earnings (P/E) ratio of around 25 compared to the Footsieâs 19.5 as I write on 19 February.
That implies the Footsie trades at roughly a 20% discount on trailing earnings, and itâs a similar story on the income side.
The Footsieâs current dividend yield of 2.8% is comfortably ahead of the Dow’s, which tends to sit below 2%.
Itâs worth noting that a higher yield doesn’t make one index necessarily better than the other. However, it often suggests a bigger slice of expected returns comes through cash payouts, not rapid earnings growth.
Whatâs driving the difference?
I think most of the valuation gap can be explained by the make up of each index.
The Footsie leans towards banks, energy, miners, and big, steady multinational companies in healthcare and consumer staples. Those areas can churn out cash and pay chunky dividends, but theyâre not usually priced like high-growth stocks.
The Dow, meanwhile, is more of a ‘best of America’ shortlist. It blends big tech, including Microsoft, and healthcare with industrial heavyweights, consumer brands, and financials like Goldman Sachs. So the flavour is different. Thereâs more of the US growth story in the mix, even if it isnât just a tech index.
Itâs also worth separating the Dow from the wider US headlines. A lot of the excitement has been driven by the tech-focused ‘Magnificent 7’. That can pull valuations higher across the market, even when plenty of other US shares are just ticking along.
Finally, US companies have tended to return cash in a different way to their UK counterparts. Buybacks have often played a bigger role than dividends, which is one reason US indexes can look less generous on yield than the Footsie.
Key takeaways
The Footsieâs lower rating is mostly about sector mix. The large-cap index is more heavily weighted towards banks, energy, and miners, plus steady global earners in the consumer sector.
The Dow follows more of the US growth narrative and provides exposure to top US companies. Each index can provide strong diversification benefits to investors and I think there are great investment opportunities for investors to consider in both.
The post FTSE 100 vs Dow Jones: why the 20% discount? appeared first on The Motley Fool UK.
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Ken Hall has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.
