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Why I’d pick the Diageo and BAE share price for a starter portfolio

If you are building a starter portfolio of top FTSE 100 stocks, these two UK-listed global giants should definitely figure in your calculations.

That’s the spirit

Spirits giant Diageo (LSE: DGE) is a £62.5bn global drinks colossus with a raft of huge brand names, including Guinness, Johnnie Walker, Captain Morgan, Smirnoff, Tanqueray, Baileys and more. Long-term share price performance has been suitably strong, with the stock more than doubling over the past decade, and rising 33% in the last three years.

Recent growth has been slower than the explosive stuff we saw under its acquisition-hungry former chief executive Sam Walsh, who quit in 2013 with a leaving gift of £46m. Successor Ivan Menezes has switched focus to premium quality brands over quantity, and it seems to be the right strategy.

Easy to swallow

Two things rarely change about Diageo. First, it typically comes with a high-end valuation of around 24 times earnings, reflecting its popularity. This makes today’s forecast valuation of 21.3 times earnings almost look like a bargain. Secondly, its yield always looks relatively low, currently a forecast 2.6%, covered 1.8 times, well below the current FTSE 100 average of 4.1%.

Those two numbers would put me off many companies, but not Diageo. Its premium valuation is routinely justified by share price performance, while the dividend policy is progressive: in January, management hiked its interim dividend by 5% to 24.9p per share.

Throw in global diversification, which means that when vodka sales fall in the US, as they did last year, gin sales may compensate by rising in Europe and it looks a great pick. My Foolish colleague Royston Wild likes Diageo so much, he would buy and hold it forever. Me too.

All Systems go

My second pick is aerospace and defence giant BAE Systems (LSE: BA), one of the jewels in the crown of British engineering. Its share price fell last year among fears about weak earnings growth, Eurofighter uncertainty, and squeezed UK defence spending. The drop of 4% was in marked contrast to a racier performance by its sector rivals in Europe, which grew 9%, and defence stocks, up 44%, as international uncertainty persuaded Western governments to ramp up their defence spending.

BAE Systems is now playing catch-up and this could be a good opportunity to climb on board, with the stock trading at a relatively lowly forecast valuation of 14.1 times earnings. Fellow Fool Ian Pierce goes as far as to argue that it could just be the buy of the decade, citing a sharp fall in its net debt position from £1.54bn to £752m, and a similarly hefty drop in its pension deficit, which has shrunk from £6.1bn to a more manageable £3.9bn.

Join the jetset

City analysts reckon EPS could fall 2% this year, but are looking forward to a rise of 7% in 2019. By then the forecast yield should hit 3.9%. Cover is currently 1.9. Brexit is a concern, amid suggestions that the UK group could be locked out of the programme to develop a new warplane to replace Eurofighter and Rafale jets. However, BAE Systems still looks a strong defensive buy for long-term investors with a head for heights.

Buy-And-Hold Investing

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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has recommended Diageo. 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.