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A Blue-Chip Starter Portfolio: HSBC Holdings plc, Vodafone Group plc, Tesco 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) Technology 881 33.3 0.9
BHP Billiton Basic Materials 1,913 12.1 4.0
British American Tobacco Consumer Goods 3,476 15.5 4.3
GlaxoSmithKline Health Care 1,573 14.4 5.3
HSBC Holdings (LSE: HSBA) Financials 597 10.6 5.4
National Grid Utilities 837 15.1 5.2
Rolls-Royce Industrials 1,069 15.5 2.3
Royal Dutch Shell Oil & Gas 2,551 11.6 4.5
Tesco (LSE: TSCO) Consumer Services 284 10.7 5.0
Vodafone (LSE: VOD) (NASDAQ: VOD.US) Telecommunications 196 27.5 5.9

Excluding tech share ARM Holdings, the companies have an average P/E of 14.8 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 2014 14.8 4.7
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 P/E rating of 14.8 is at its highest since I’ve been tracking the shares; and is moving towards expensive, on the basis that FTSE 100 long-term average is around 14. However, it’s worth noting that the P/E of Vodafone (27.5) is having a significant effect on the group average this quarter.

Vodafone

Vodafone’s P/E is currently so high because the company has sold its stake in cash machine Verizon Wireless, and is now in a position of having to invest — both organically and, more riskily, by acquisition — to replace the lost earnings (as well as funding shareholders’ dividends).

The replacement of lost earnings won’t happen overnight, and analyst forecasts have earnings covering only 62% of the predicted dividend payout. While Vodafone can dip into cash to make up the difference in the short term, this isn’t a sustainable situation.

As such, investors are very much relying on management’s ability to bulk up earnings through acquisitions if Vodafone is to maintain, let alone grow, the dividend — as well as justify that P/E of 27.5! The company looks a relatively risky proposition during this period of transformation.

ARM

Britain’s technology champion ARM has an even higher P/E than Vodafone. But ARM is a recognised high-growth company, and doesn’t have to do anything much different to what it has been doing to keep earnings soaring upwards. Furthermore, ARM’s current P/E is the lowest it’s been at any of my quarterly review dates.

When I spotlighted ARM at 795p this time last year, the P/E was 34.6. The shares are higher today, at 881p, but earnings progress over the year and further progress forecast by analysts for the next 12 months mean the P/E is now actually lower — at 33.3. So, this could be a good time to pick up a blue-chip tech stock that is always expensive relative to the wider market.

Tesco and HSBC

We’ve seen the reverse situation to ARM with troubled supermarket Tesco. I highlighted Tesco last quarter at 298p when the P/E was 10.3. While the price has now dropped to 284p, the P/E has actually risen to 10.7, because the company has suffered further earnings downgrades from analysts.

Similarly, HSBC — 611p last quarter; now 597p — has seen its P/E rise from 10.4 to 10.6. Still, both Tesco and HSBC are on well-below-average earnings ratings (and above-average dividend yields), so could reward long-term investors, even if analyst downgrades haven’t yet reached bottom.

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