A Blue-Chip Starter Portfolio

Article written by G A Chester, for The Motley Fool (http://bit.ly/1CenwKg)

Every quarter I take a look at the largest FTSE 100 companies in each of the index’s 10 industries to see how they shape up as a potential “starter” portfolio.

The table below shows the 10 industry heavyweights and their current valuations based on forecast 12-month price-to-earnings (P/E) ratios and dividend yields.

Company Industry Recent share price (p) P/E Yield (%)
ARM Holdings (LSE: ARM) Technology 1,105 34.1 0.8
BHP Billiton Basic Materials 1,474 14.7 5.9
British American Tobacco Consumer Goods 3,489 16.3 4.5
GlaxoSmithKline Health Care 1,546 16.7 5.2
HSBC Holdings (LSE: HSBA) Financials 574 10.2 6.1
National Grid (LSE: NG) Utilities 865 14.7 5.2
Rolls-Royce Industrials 953 15.6 2.6
Royal Dutch Shell Oil & Gas 2,099 14.8 5.9
Vodafone Telecommunications 220 35.6 5.4
WPP Consumer Services 1,531 15.9 2.9

Excluding tech share ARM Holdings, the companies have an average P/E of 17.2 and an average dividend yield of 4.9%.

My rule of thumb for the group of nine (excluding ARM) is that an average P/E below 10 is bargain territory, 10-14 is decent value, while above 14 starts to move towards expensive.

The current group P/E rating of 17.2 is at its highest since I’ve been tracking the shares, and has moved well above the FTSE 100 long-term average P/E of 14.

The growing disconnect between P/E and yield also seems a cause for concern. The last time the yield was as high as the current 4.9% was in January 2013 — when the P/E was just 11.4. It may be that we’ll see a period of little or no dividend growth among the heavyweights (or even a rebasing of some dividends) to bring the yield down to a level that better reflects the high P/E and a low interest-rate environment in which other assets are yielding very little.

HSBC is the current highest yielder of the group at 6.1%, which is higher than it’s been in any of my previous quarterly reviews. At least the P/E is in sync at a lowly 10.2 — the standout “value” P/E in the table of companies above. Still, it has to be said that HSBC has been looking good value for quite a long time, and at higher share prices: for example, this time two years ago, the P/E was 10.7 … but the shares were 703p. HSBC, then, has been something of a value trap, but could be a great buy now if earnings finally start to rise (supporting the dividend in the process) and the shares re-rate. Certainly, though, there is above-average risk for the potential high reward.

ARM Holdings is a company that’s had no problem growing earnings, and is a mirror opposite to HSBC. If we go back to October 2012, the P/E was 34.1 at a share price of 575p. Today, the shares are 1,105p — but the P/E is still 34.1. “Price is what you pay, value is what you get”, as legendary investor Warren Buffett once said. So, while ARM’s “price” is higher today than in October 2012, the “value” (as measured by the P/E) is the same. ARM’s P/E has been above 40 in some of my quarterly reviews, and the current rating looks reasonable value for a tech growth share.

For a steadier prospect, I’d highlight National Grid at this time. The P/E of 14.7 is as low as it’s been since my January 2014 review, and has been above 15 at each of the last four quarterly review dates. The shares are some 10% below their 52-week high — despite modest earnings upgrades — and the dividend yield of 5.2% also looks attractive.

Company website: www.directmarkettouch.com

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