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Top buys for a FTSE 100 starter portfolio for 2018

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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.

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Company Industry Share price at 1/1/18 (p) P/E Yield (%)
BAE Systems (LSE: BA) Industrials 573 13.1 3.9
British American Tobacco Consumer Goods 5,018 16.2 4.0
GlaxoSmithKline Health Care 1,323 12.3 6.0
HSBC Holdings Financials 767 13.9 5.2
National Grid Utilities 875 14.5 5.3
Rio Tinto (LSE: RIO) Basic Materials 3,942 12.7 4.7
Royal Dutch Shell Oil & Gas 2,509 15.8 5.6
Sage Technology 798 23.0 2.2
Tesco Consumer Services 209 16.5 2.3
Vodafone Telecommunications 235 24.8 5.7

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 as a whole for the last four quarters and five years.

  P/E Yield (%)
January 2018 16.3 4.5
October 2017 16.5 4.5
July 2017 16.4 4.6
April 2017 16.8 4.6
January 2017 17.0 4.4
January 2016 13.7 6.0
January 2015 13.5 4.8
January 2014 12.7 4.5
January 2013 11.7 4.6

My rule of thumb 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 P/E has come down to 16.3 from 17 in January last year but remains above my ‘good value’ band. This doesn’t mean the group of companies can’t deliver a good return for investors, just that it could take longer to achieve than if the stocks were bought at a lower valuation.

Top picks

I’ve recently written about the attractive rating of National Grid, which has a relatively low P/E for a utility and a great dividend yield. GlaxoSmithKline, with the lowest P/E and highest yield of all, also looks excellent value to me and to my Foolish colleague Alan Oscroft, who has named it his FTSE 100 stock pick for the next decade.

Two others stocks I also rate as particularly good ‘buy’ candidates today are BAE Systems and Rio Tinto.

Solid defence

BAE’s shares are 15% below their 52-week high and the P/E of 13.1 compares with a range of between 13.9 and 14.4 at my last four quarterly reviews. The dividend yield of 3.9% isn’t spectacular but is very decent and I have to go back to my October 2016 review to find it above the current level.

In its last trading update, three months ago, BAE said the US defence market outlook remains positive and export campaigns in all domains continue to be well supported by the UK government. The company also announced organisational changes and workforce reductions that will drive competitiveness, accelerate technology innovation and deliver continued improvements in efficiency and operational excellence. I believe the stock remains a solid buy in the defence sector.

Mining a rich vein

In contrast to the lacklustre performance of BAE’s shares, those of mining giant Rio Tinto are at a 52-week high. Furthermore, they’ve more than doubled since the last time I highlighted the stock for you, at 1,643p back in January 2016. At that time, the P/E was 11.1. Despite the huge rise in the shares since, the P/E today continues to be attractive at 12.7. This is because earnings have improved dramatically.

Rio has restructured its business significantly since over-expanding and making some ill-judged acquisitions at the height of the last mining cycle. New management has a relentless focus on cash generation and disciplined capital allocation. This bodes well for shareholders and with its long-life, low-cost mines, I rate Rio a sound buy for long-term investors.

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended HSBC Holdings, 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.

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