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A Blue-Chip Starter Portfolio: Tesco PLC, BHP Billiton plc And ARM Holdings plc

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) (NASDAQ: ARMH.US) Technology 795 34.6 0.8
BHP Billiton (LSE: BLT) Basic Materials 1,682 9.3 4.8
British American Tobacco Consumer Goods 3,368 14.1 4.6
GlaxoSmithKline Health Care 1,648 13.5 4.6
HSBC Holdings Financials 682 10.3 5.2
National Grid Utilities 746 13.7 5.7
Rolls-Royce Industrials 1,134 16.4 2.0
Royal Dutch Shell Oil & Gas 2,176 7.9 5.4
Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) Consumer Services 331 9.9 4.7
Vodafone Telecommunications 188 11.5 5.5

Excluding tech share ARM Holdings, the companies have an average P/E of 11.8 and an average dividend yield of 4.7%. The table below shows how the current ratings compare with those of the past.

  P/E Yield (%)
July 2013 11.8 4.7
April 2013 12.3 4.6
January 2013 11.4 4.9
October 2012 11.1 5.0
July 2012 10.7 5.0
October 2011 9.8 5.2

As you can see, the group of nine industry heavyweights was rated more highly last April than at any time in the past couple of years. This quarter, the P/E has moderated and the dividend yield has increased a notch.

My rule of thumb for this group is that an average P/E below 10 is firmly in ‘bargain’ territory, while a P/E above 14 starts to move towards expensive. On this spectrum, I think the market is currently offering a reasonably good opportunity for long-term investors to buy a blue-chip bedrock of industry heavyweights for a UK equity portfolio — compared with what I described as a fair opportunity last quarter.

Going beyond the overall average to the individual company level, there are three stocks in particular that have caught my eye.

Tesco

After the recent weakness in equity markets, the P/Es of eight of the UK’s 10 industry giants are lower today than when I last looked at them in April. Tesco is among the companies whose P/Es have fallen the most.

The shares of the UK’s no. 1 supermarket have dropped 13% to 331p from 382p. The P/E has come down to 9.9 from 11.6, while the yield has gone up to 4.7% from 4.1%. Tesco’s P/E and yield are back to a level not seen in my quarterly reviews since October last year.

BHP Billiton

BHP Billiton’s shares have seen a similar degree of weakness to Tesco’s. Since April, the global mining giant’s shares have fallen 12% to 1,682p from 1,915p. The P/E has come down to 9.3 from 10.1, while the yield has gone up to 4.8% from 4.1%.

Going back to the start of the year, BHP Billiton’s shares were as high as 2,145p, with the P/E at 12.8 and the yield as low as 3.6%. Moreover, the market’s spurning of the company — and miners in general — stretches way back beyond six months. BHP Billiton’s recent share-price low of 1,670p was last seen during the summer of 2009.

ARM Holdings

It may seem strange that I’m highlighting tech company ARM Holdings when it has the highest P/E and lowest yield of all 10 stocks. “What about Shell or HSBC?” I hear you say. Well, while Shell and HSBC are offering low P/Es and high yields, the ratings are not markedly changed from when I highlighted the two companies as value opportunities last quarter.

In contrast, ARM’s shares have fallen 14% to 795p from 921p. The P/E has come down to 34.6 from 44.9, while the yield — less important for a growth company such as ARM — has nudged up to 0.8% from 0.6%. If you’re interested in having a high-growth tech blue chip in your portfolio at all, it’s rare to find ARM’s P/E as low as it is today.

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> G A Chester does not own any shares mentioned in this article. The Motley Fool owns shares in Tesco.