For anyone seeking shares for a FTSE 100 starter portfolio, obtaining companies with strong risk/reward ratios could be a good place to start. After all, there are a number of stocks which offer high potential rewards, but perhaps fewer which do so while at an acceptable level of risk. This is especially the case now that the index has risen following a Bull Run, with margins of safety now relatively small. Despite this, there are still stocks which could offer favourable risk/reward ratios, such as these two companies.
Providing an operational review for its full year on Wednesday was resources company BHP Billiton (LSE: BLT). It was able to meet its production guidance in areas such as petroleum and iron ore. However, copper production was lower than the previous year due in part to industrial action at one of its key assets, as well as unplanned maintenance and power outages elsewhere. However, since the company is relatively diversified, it was able to deliver a strong performance despite the challenges it faced.
In fact, the company’s diversification is a major ally for investors. While there are enticing investment opportunities available in the mining and oil & gas sectors at the present time, BHP Billiton offers exposure to a range of commodities which span both industries. Therefore, even if the prices of multiple commodities fall, it may be able to outperform industry rivals on a group basis. This could mean lower risks, which may create more consistent and sustainable shareholder returns.
With BHP Billiton trading on a price-to-earnings (P/E) ratio of 13.5, it appears to offer upside potential from a rerating. Certainly, the resources sector is a relatively volatile industry in which to invest. However, with a wide margin of safety and diverse asset base, BHP Billiton appears to be a sound buy.
Also offering impressive return potential, given its level of risk, is Imperial Brands (LSE: IMB). The company trades on a P/E ratio of 12.7, which is hard to justify given its relatively reliable growth outlook. It is expected to post a rise in earnings of 8% this year, followed by 3% next year. Beyond that, more growth seems likely as demand for tobacco products and next generation nicotine products looks set to remain buoyant. Along with price rises and greater efficiencies, this should lead to a higher valuation being warranted over the medium term.
As well as its growth potential, Imperial Brands also offers a relatively low risk profile. It operates in a highly defensive industry where demand does not fluctuate significantly from year to year. It also has a high degree of customer loyalty, as well as a diversified product stable and geographical mix. Therefore, its risk/reward ratio seems impressive, making it a strong contender for a starter FTSE 100 portfolio.
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Peter Stephens owns shares of BHP Billiton and Imperial Brands