British shares look cheap, pushing dividend yields to impressive levels. At least, that’s what the numbers indicate. Looking at the cyclically-adjusted P/E ratio, or CAPE (which averages earnings over a 10-year period), the FTSE 250 currently sits at around 18.7. By comparison, its 30-year historical average is closer to 25. And a quick glance across the pond reveals that the S&P 500 is currently at 32.2!
As a mid-cap index, the FTSE 250 is mostly known for its growth opportunities. But it’s also home to a wide range of lucrative dividend-paying businesses. In fact, as of January, there are more than 60 firms with a dividend yield of at least 5%.
Opportunity and risk
Using the UK’s flagship mid-cap index as a proxy for the British stock market, its current CAPE suggests that UK shares are trading at an average discount of 25.2%. That certainly sounds like an extreme overcorrection from panicking investors during the recent market turmoil. And this level of discounting hasn’t been seen since the 2008 financial crisis, around 14 years ago.
If the next bull market ends up being just as long, 2024 could very well be a once-in-a-decade chance to load up an ISA with cheap, top-notch stocks. However, before getting too excited, it’s important to understand why pessimism appears to be so high.
As of November, the UK consumer price index has dropped to 3.9%, bringing it very close to the Bank of England’s ideal range of 2-3%. Yet, not everything has fallen back in line. For example, food inflation is still as high as 9.2%, while rent is rising by 6.4%!
In other words, some of the biggest and most common expenses for most households are still rising drastically. And with pressure on consumer wallets still rising, the headwinds for many businesses are still blowing strong.
Focus on the long run
The short term is still riddled with uncertainty. And for some weaker businesses, the current economic climate may cause permanent damage. But for companies with strong balance sheets and robust cash flows, these headwinds may be nothing more than a speed bump.
If that’s the case, then locking in impressive high yields within an ISA today could prove immensely rewarding a few years down the line. This is especially true if the businesses are able to hike dividend payments even higher.
After all, even a modest yield can turn into a monstrous one. Take Safestore as an example. Investors who’ve held on across the last decade have seen their yield rise beyond 50% on an original cost basis!
Finding the next Safestore today is obviously easier said than done, with countless factors to take into consideration. However, by filtering out overleveraged enterprises with low free cash flow margins, investors can quickly narrow down their investigation.
