The main benchmark for shares listed on the London Stock Exchange is the FTSE 100. Widely quoted in reports on the financial markets, its constituents make up 80% of the UK market by valuation.

But how much do you know about its composition? For example, upwards of 70% of its earnings are derived overseas despite the FTSE 100 being London’s flagship stock index. As a result, its relationship with the UK economy is fairly loose.

In this article we will deconstruct the index, examining how it has changed over time, what drives it, the biggest sectors and reveal three of our favourite FTSE 100 companies.

The make-up of the index has changed substantially in recent times, although one of the elements remaining reasonably consistent is that a good chunk of the index consists of natural resource companies.

All FTSE indices are weighted by market capitalisation, so that the larger companies make more of a difference to each index than smaller companies in terms of index performance.

The dominance of oil companies and miners in the FTSE 100 leads therefore to a close correlation with the fortunes of fast growing developing economies like China which consume a large proportion of the world’s natural resources.

The recent wobble for the FTSE is less of a function of Brexit-related uncertainty and more linked to global tensions over trade.

---

WHAT DRIVES THE INDEX?

Currency 

The fact such a large proportion of the earnings from the index are international means currency movements are a big factor. The plunge in the pound in the wake of the Brexit vote and its continued volatility has probably been the main driving force of the FTSE 100 in the last two-and-a-bit years.

Weak sterling lifts the index as earnings in other major currencies are worth more when translated back into sterling.

Dividends

Many investors invest in equities for the income from dividends. According to AJ Bell’s latest Dividend Dashboard, constituents of the index are forecast to pay out a record £88.8bn in dividends this year. This adds up to an average FTSE 100 dividend yield of 4%, although a lot of this income is dependent on the fortunes of energy and financial stocks.

Energy and metals prices

Dominance by resource companies means commodity market movements have a material impact. Weakness in the copper price since June 2018 has helped keep a lid on any gains for the index.

Results

Strong or weak results from some of the largest constituents of the FTSE 100 like HSBC (HSBA), Royal Dutch Shell (RDSB) and GlaxoSmithKline (GSK) can drive the whole index higher or lower. (TS)

---

WHAT IS THE OUTLOOK FOR THE FTSE 100’s LARGEST SECTORS?

As of 31 July 2018, four super sectors had a weighting of more than 10% in the FTSE 100 index. The outlook for these industries will have a big impact on how the index performs going forward.

Oil and Gas

Weighting: 16.6%

Source: FTSE Russell, 31 July 2018

Oil and Gas is the largest individual super sector on the FTSE 100 but actually comprises just two companies, BP (BP.) and Royal Dutch Shell.

A recovery in oil prices from the 2014 crash has helped these businesses put themselves on a more sustainable footing.

Crucially it has allowed them to reach a point where they can fund their prized dividends from cash flow rather than debt or by issuing dividends in shares (scrip dividends). BP has just increased its dividend for the first time in four years.

Management of both BP and Shell have reached a point where they can balance the books at around the $50 per barrel mark. This is therefore a key level to watch for investors in the sector.

As we write the Brent crude index, the global benchmark for oil, is trading at around $70 per barrel. Earlier in the summer it had been closer to $80 per barrel on fears over the impact of new sanctions on major oil producer Iran. Trade war fears have taken some of the heat out of the commodity.

The direction oil prices take in the remainder of the year will determine if the current 2018 earnings per share and dividend per share forecasts from BP and Shell can be delivered or even exceeded.

Based on these forecasts, BP trades on a price to earnings (PE) ratio of 12.5 and offers a 5.8% dividend yield compared with Shell’s PE of 11.8 and 6% yield. (TS)

Banks

Weighting: 12.7%

Source: FTSE Russell, 31 July 2018

The FTSE 100 is heavily skewed in terms of profits and dividends into a few sectors, one of these being banks.

Bank bashing had been one of the top national pastimes since the financial crisis, but this is now ebbing away as we finally come to the end of a prolonged period of misconduct charges being brought against these institutions.

The banks passed the Bank of England’s stress tests last year and for 2018 are forecast to contribute a large percentage of the profits from the FTSE 100.

The earnings backdrop should be supportive of dividend payments by the banks, especially now Lloyds (LLOY) has restored its dividend and Royal Bank of Scotland (RBS) recently said it would pay its first dividend in 10 years.

HSBC and Lloyds together account for 12% of forecast dividend payments by the FTSE 100 for 2018.

Banks faced the scrutiny of regulators after the global financial crisis but the introduction of European Basel rules that enforced capital requirements doesn’t seem to have fatally impaired these companies’ dividend paying capabilities. (DS)

Personal and Household Goods

Weighting: 12.4%

Source: FTSE Russell, 31 July 2018

This is a diverse collection of companies which encompasses the housebuilders alongside luxury goods firm Burberry (BRBY), the tobacco stocks and consumer goods giants Reckitt Benckiser (RB.) and Unilever (ULVR).

The importance of this space to the FTSE 100 could diminish in the near future. In June Unilever indicated it would likely exit the index after it completes the relocation of its headquarters from London to the Netherlands – a move which has been linked to the Brexit process.

In July Reckitt surged higher on better-than-expected quarterly sales growth, though this followed a run of more disappointing news.

British American Tobacco (BATS) and Imperial Brands (IMB) were once considered defensive plays offering a strong and sustainable source of income. Today the picture is different thanks to concerns over declining cigarette volumes as global governments crack down on the industry.

The tobacco sector is widely transitioning to so-called Next Generation Products or NGPs including e-cigarettes and this could put earnings under pressure for the near-term at least.

Elsewhere, the UK housing market has cooled of late, and this is starting to be reflected in the average selling prices achieved by the listed contingent of housebuilders. If house prices continue to decline, these businesses will have to drive sales through higher volumes to achieve growth. This represent a significant challenge given rising staff and input costs. (TS)

Healthcare

Weighting: 10.2%

Source: FTSE Russell, 31 July 2018

The Healthcare sector in the FTSE 100 comprises five companies: AstraZeneca (AZN), GlaxoSmithKline, NMC Health (NMC), Smith & Nephew (SN.) and Shire (SHP).

The sector is set to shrink following the acquisition of Shire by Japanese pharmaceutical colossus Takeda, assuming the deal completes.

AstraZeneca is making good progress as it targets a return to sales growth by the end of 2018. 

At rival GlaxoSmithKline, speculation about spinning off its consumer division has re-emerged as the company aims to boost spending to support its drugs pipeline.

For these well-known names, pre-tax profit is expected to mainly rise over the next three years, but dividend growth is expected to be subdued.

Private hospital operator NMC Health is forecast to deliver rising profits and dividends over the next three years with pre-tax profit expected to more than double from $219.4m in 2017 to $467.6m in 2020.

Smith & Nephew is underperforming compared to its peers after downgrading annual sales growth twice since November amid softer market conditions. Its pre-tax profit is forecast to fall from $993m in 2017 to $960m this year before rising to $1.06bn in 2019, while dividends aren’t expected to start growing again until 2019. (LMJ)

---

THREE OF OUR FAVOURITE FTSE 100 STOCKS

CRODA (CRDA) £51.38 BUY

We’re big fans of chemicals business Croda (CRDA) which creates and sells speciality chemicals for beauty products and ingredients for lubricants, as well as developing products to boost yields for farmers. It is tapping into the growing demand for premium care products.

Under its strategy, the company aims to boost sales growth, generate stronger margins and invest in disruptive technologies, reflected in the recent acquisition of marine biotechnology firm Nautilus which uses microbial biodiversity to develop new actives and ingredients.

We rate Croda as a reliable growth stock, delivering sales and profit growth nearly every year over the past decade, and this is expected to continue.

Sales are forecast to increase from £381.8m last year to £404.3m this year and progress further to £438.9m in 2019 and £468.1m in 2020.

Pre-tax profit is forecast to climb from £320.3m last year to £334.4m in 2018, before jumping to £365.2m in 2019.

Driving growth at Croda is its Personal Care division with sales rising 9.3% in the first half of 2018 and operating profit growth of 6.1% on constant exchange rates.

The personal care market could be lucrative for some time as consultancy Euromonitor estimates around 4% compound annual growth in these products between 2016 and 2021.

Investors looking for income should note that Croda is forecast to deliver growing dividends over the next few years. According to analyst estimates, the dividend will jump by more than 30% from their current level by the end of 2020. And Croda is expected to reward shareholders with a special dividend later this year. 

NATIONAL GRID (NG.) 822.6p BUY

There is one particularly compelling reason to consider owning shares in National Grid (NG.)  – inflation-proof income.

With latest figures from the Office for National Statistics (ONS) showing the cost of living in Britain on the rise, investors who rely on growing dividends to help pay their monthly bills might well be lured by the UK’s largest utility company’s commitment to grow its dividend to match RPI (retail price index) inflation or better ‘for the foreseeable future’.

RPI inflation in July came in at 3.2%, according to ONS data, and the Office for Budget Responsibility is forecasting that figure to settle at around 3% out to 2023.

National Grid runs much of the UK’s electricity and gas supply infrastructure, with similarly regulated operations in the US. It has a long track record of steadily increasing its annual payout to shareholders dating beyond the 2002 merger with Lattice, which formed an electricity and gas transmission national champion.

It has missed its dividend growth target just once in the past 10 years (2012), when RPI was coming down from a spell running at 5%-plus.

This sort of inflation-beating track record is matched by other utility stocks (electricity, gas, water suppliers, for example) yet National Grid is the UK operator least threatened by a possible stiffer regulatory climate in the future.

UK energy suppliers, such as British Gas-owner Centrica (CNA) for example, are facing the introduction of tariff price caps which could limit dividend growth in the future. UK water companies have also been dogged by political and regulatory issues.

This arguably makes National Grid the UK utility company least likely to give investors sleepless nights. This year’s (to 31 March 2019) dividend is forecast at 47.24p, implying a 5.7% yield based on the current share price, with future payouts expected to rise roughly 3% a year out to 2021. 

PRUDENTIAL (PRU) £17.20 BUY

Insurance behemoth Prudential (PRU) is growing at a healthy click and has plans to enhance shareholder value. The company hopes to spin out its UK operations as a separately-listed business called M&G Prudential. In essence, Prudential’s shareholders will get free shares in M&G which will focus on savings and retirement needs for individuals in the UK and Europe.

This demerger would leave its faster growth US and Asian businesses as a separate entity. While it may seem that investors may have more interest in the high growth parts of the business, it should be remembered that M&G and the PruFunds arm both had record inflows in 2017.

Investing in companies which have announced a demerger can have upsides generally. A demerged business can allow management to take control of its own destiny and make decisions that best serves its needs rather than those of a larger conglomerate.

They can also be more entrepreneurial when demerged and remuneration for key players can be more closely aligned with business objectives and performance.

Mike Wells, chief executive of Prudential, reinforced the above point saying that following the separation M&G Prudential will have more control over its business strategy and capital allocation.

The existing group released its half year results in August and its growth credentials were on show again. Its operating profit rose 9% to £2.4bn year-on-year with its chief executive saying the performance has been led by Asia again.

We note recent rumours that a Chinese financial services firm was considering a bid for Prudential’s Asian business.

Prudential says the working age population in Asia is growing by 1m people every month and they are under-protected, creating a huge opportunity for the business.

In the US, it believes 10,000 people will be retiring every day over the next 20 years, creating a growing need for protection products.

---

THE COMPLETE FTSE 100

 

‹ Previous2018-08-23Next ›