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Top buys for a Footsie starter portfolio

Every quarter I take a look at the top 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 heavyweights and their valuations based on forecast 12-month price-to-earnings (P/E) ratios and dividend yields.

Company Industry Recent share price (p) P/E Yield (%)
BAE Systems Industrials 643 14.4 3.5
British American Tobacco Consumer Goods 5,300 18.1 3.6
GlaxoSmithKline Health Care 1,660 14.9 4.8
HSBC Holdings Financials 651 13.3 6.3
National Grid Utilities 1,014 15.7 4.5
Rio Tinto Basic Materials 3,210 9.1 6.3
Royal Dutch Shell Oil & Gas 2,185 14.2 6.8
Sage (LSE: SGE) Technology 631 18.6 2.7
Tesco (LSE: TSCO) Consumer Services 186 18.7 1.7
Vodafone Telecommunications 208 31.3 6.0

Before looking at which individual companies might be particularly good buys today, let’s get a feel for the overall value.

The table below shows average P/Es and yields for the group for the last four quarters and four years.

  P/E Yield (%)
April 2017 16.8 4.6
January 2017 17.0 4.4
October 2016 17.3 4.0
July 2016 17.2 4.4
April 2016 16.4 5.0
April 2015 14.9 4.8
April 2014 12.8 4.6
April 2013 12.4 4.4

My rule of thumb for the group is that an average P/E below 10 is bargain territory, 10-14 is good value and above 14 starts to move towards expensive.

As you can see, the group P/E is currently towards the expensive end of my range — although it has edged lower over the past three quarters and the dividend yield has ticked higher. This seems to reflect rising earnings and dividend forecasts (probably in large part due to weak sterling helping these multinational businesses) and share prices rising not quite as fast as the forecasts.

Which stocks offer good value today?

HSBC, Rio Tinto and Royal Dutch Shell have the three lowest P/Es and highest yields. They continue to look good value today but I’ve highlighted them for you at much lower prices previously, so I’m going to turn my attention to two companies that aren’t obviously cheap but which I think are worth considering at this time.

I have to go back to my quarterly review of January 2016 for the last time Tesco (LSE: TSCO) was on a P/E of below 20. Today’s P/E of 18.7 is still relatively high, but with chief executive Dave Lewis’s turnaround plan gaining traction, the multiple falls to nearer 14 on a 24-month view.

When you consider that Tesco’s annual revenue is about one-and-a-third times that of Sainsbury’s and Morrisons combined, it should be no suprise that it has taken time to manoeuvre this metaphorical super tanker back on course. It’s now looking like full steam ahead and with its economies of scale, Tesco should be able to print above-sector-average profit margins in due course.

A deal to acquire leading wholesaler Booker may or may not go ahead, but either way, I believe now could be a good time to pick up shares in the UK’s dominant supermarket.

Also good value

Finally, I think shares of accountancy software and services giant Sage (LSE: SGE) could also be worth buying at their current level. The P/E of 18.6 is on a par with Tesco’s, but tech company multiples tend to be higher than average and Sage is trading at a decent discount to its sector peers.

This global operator has been investing and transforming its business model for a new phase of growth. I’m expecting to see both rising revenues and expanding profit margins coming through over the next few years. Sage may even be able to exceed consensus City forecasts, which are currently depressed by a couple of particularly bearish analysts.

Quality businesses

Of course, while my quarterly review focuses on the 10 industry heavyweights, there are plenty more blue chips to choose from in the FTSE 100. In fact, the Motley Fool's leading analysts have been scouring the whole index to identify the Footsie's highest quality businesses for 2017 and beyond.

Our experts have narrowed the field down to five companies they believe will be top-notch long-term performers. You can read all about these blue-ribbon blue chips in this exclusive FREE report.

The report comes with no obligation, simply click here now.

G A Chester has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended Booker, HSBC Holdings, Rio Tinto, Royal Dutch Shell B, and Sage Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.