How do the UK's ten industry giants shape up as a starter portfolio?
Here at The Motley Fool, we've long extolled the virtues of low-cost index trackers as a one-stop shop for equity investment. Tracker funds simply replicate an index, such as the FTSE 100 or FTSE All-Share.
However, index tracking isn't everyone's cup of tea. Some people prefer to invest directly in the shares of individual companies.
Shares vs trackers
One reason some investors prefer shares is because of the industry imbalances within the FTSE indices. Some industries are more heavily represented than others.
At the broadest level, there are ten industry sectors in the official classification. The table below shows the proportion of these industries within the FTSE 100 (and, thus, a FTSE 100 tracker).
|Oil & Gas||20|
As you can see, the imbalances are quite substantial. Financials, for example, represent one tenth of the ten industries, but make up a fifth of the index. At the other end of the scale, Technology also represents one tenth of the industries, but makes up just one hundredth of the index.
Financials, Oil & Gas, Basic Materials (mainly mining) and Consumer Goods are all 'overweight', while the other six sectors are all 'underweight'.
Investors in trackers have to live with the sector skews of the index. Investors in individual companies are of course free to choose the industries they invest in and the weight they give them.
Some investors argue that, because we can't know how the different sectors will perform in the future, 'equal weighting' between industries is the most logical approach.
A starter portfolio
From time to time, I take a look at the largest FTSE 100 companies in each of the ten industries to see how they shape up as a potential 'starter' portfolio.
The table below shows the ten industry heavyweights and their valuations based on forecast twelve-month price/earnings (P/E) ratios and dividend yields.
| ||Industry||Share price|
|HSBC (LSE: HSBA)||Financials||481||7.3||5.9|
|Royal Dutch Shell (LSE: RDSB)||Oil & Gas||1,933||6.8||5.6|
|BHP Billiton (LSE: BLT)||Basic Materials||1,669||5.8||4.2|
|Brit Am Tobacco (LSE: BATS)||Consumer Goods||2,706||12.9||5.1|
|Tesco (LSE: TSCO)||Consumer Services||378||10.0||4.3|
|GlaxoSmithKline (LSE: GSK)||Health Care||1,315||11.0||5.4|
|Vodafone (LSE: VOD)||Telecommunications||167||10.1||7.2|
|Rolls-Royce (LSE: RR)||Industrials||579||12.0||3.2|
|National Grid (LSE: NG)||Utilities||632||12.2||6.3|
|ARM (LSE: ARM)||Technology||530||40.6||0.7|
These are all huge companies. Even the smallest -- microchip designer ARM -- is capitalised at more than £7bn.
As a value investor, I baulk at ARM's lofty P/E and low dividend yield. But the companies in the other nine sectors look attractively valued against their average historical ratings.
The nine companies have an average P/E of 9.8, while the average yield is 5.2%. My rule of thumb for this group of industry giants is that an average P/E below 10 and a yield above 5% puts them firmly in 'good value' territory.
Valuation is all-important in successful investing. Building a diversified portfolio is not about collecting companies and sectors as if they were stamps, or about being overly obsessed with equal weighting.
Nevertheless, it seems to me that the market is currently offering a good opportunity to buy a blue-chip bedrock of industry heavyweights for investors who are looking to embark on building a diversified portfolio of UK equities.
Do you think this group of companies shapes up as a starter portfolio? Let me know your views, for or against, in the comments box below!
More from G A Chester:
> The Motley Fool owns shares in GlaxoSmithKline and Tesco.