A Blue-Chip Starter Portfolio: HSBC Holdings plc, Tesco PLC and Rolls-Royce Holding PLC

How do HSBC Holdings plc (LON:HSBA), Tesco PLC (LON:TSCO), Rolls-Royce Holding PLC (LON:RR), and the UK’s other seven industry giants shape up as a starter portfolio?

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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 Technology 978 38.1 0.7
BHP Billiton Basic Materials 1,852 10.9 4.1
British American Tobacco Consumer Goods 3,340 15.1 4.5
GlaxoSmithKline Health Care 1,618 14.2 5.1
HSBC Holdings (LSE: HSBA) (NYSE: HSBC.US) Financials 611 10.4 5.4
National Grid Utilities 830 15.1 5.3
Rolls-Royce (LSE: RR) Industrials 1,077 15.6 2.2
Royal Dutch Shell Oil & Gas 2,340 11.1 4.9
Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) Consumer Services 298 10.3 5.0
Vodafone Telecommunications 219 19.9 5.2

Excluding tech share ARM Holdings, the companies have an average P/E of 13.6 and an average dividend yield of 4.6%. The table below shows how the current ratings compare with those of the past.

  P/E Yield (%)
April 2014 13.6 4.6
January 2014 13.6 4.5
October 2013 12.2 4.7
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 earnings rating is unchanged from last quarter, and remains at its highest since I’ve been tracking the shares.

My rule of thumb 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 an opportunity nearing the upper end of fair for long-term investors to buy a blue-chip bedrock of industry heavyweights for a UK equity portfolio.

Going beyond the overall picture to the individual companies, three shares have caught my eye.

hsbcHSBC

Banks don’t come much bigger than HSBC. With a market value of £115bn, HSBC is not only a FTSE 100 giant, but also among the most valuable banking brands in the world.

HSBC’s shares have been hit by investor concerns about the slowing pace of growth in emerging markets, and the threat of a banking crisis in China, as the country seeks to rein in runaway lending, particularly in real estate. However, HSBC’s chief executive, reckons the banks are resilient enough to cope with defaults, and that there’ll be a longer-term benefit of greater credit discipline.

The uncertainty means HSBC’s shares have been trading recently at lows not seen since 2012; and on a value P/E of 10.4, with a juicy dividend yield of 5.4%.

tescoTesco

The UK’s number one supermarket is another industry heavyweight whose shares have been under the cosh. Company-specific problems — revealed by a profit warning two years ago — have been exacerbated by an intensification of competition in the UK supermarket sector.

Still, Tesco is a juggernaut with the power to plough through a price war with its mid-market rivals Sainsbury’s, Asda and Morrisons. In the longer term, Tesco’s international operations — which include a recently-announced joint venture in India — should help drive growth.

Similar to HSBC, Tesco trades on a value P/E of 10.3 and offers a 5% dividend yield.

Rolls-RoyceRolls-Royce

The visibility afforded by long-term contracts and the state of the order book means aerospace and defence company Rolls-Royce typically trades on a pretty high earnings rating and low dividend yield.

However, the company upset the market when it released its annual results last month. It wasn’t the 2013 performance that hit the shares — the performance was good — but management’s expectation of a “pause” in revenue and profit growth in 2014 as a consequence of cuts in defence spending.

Despite the chief executive being clear that “we expect growth to resume in 2015”, and the announcement of several contract wins since the results, I have to go back to my January 2013 quarterly review to find the shares and earnings rating lower than the current level. Today’s P/E of 15.6 is down from 17.6 last quarter.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester does not own any shares mentioned in this article. The Motley Fool owns shares in Tesco and has recommended shares in Morrisons and GlaxoSmithKline.

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