Every quarter I take a look at the biggest FTSE 100 companies in each of the index’s 10 industries to see how they shape up as a potential starter portfolio. At the start of 2019, the average earnings rating of this group of companies is cheaper than it’s been for over five years.
The table below shows their individual valuations based on forecast 12-month price-to-earnings (P/E) ratios and dividend yields.
|Company||Industry||Share price (p)||P/E||Yield (%)|
|British American Tobacco (LSE: BATS)||Consumer Goods||2,479||7.9||8.5|
|Rio Tinto||Basic Materials||3,690||10.6||5.9|
|Royal Dutch Shell||Oil & Gas||2,363||9.7||6.2|
The average P/E of the group is 12.3 and the average dividend yield is 5.9%. To put this into historical context, the table below shows average P/Es and yields for the last four quarters and six years.
Looking at my records, I have to go back to the October 2013 quarter to find the group average P/E as cheap as it is today. Furthermore, at 12.3, it’s firmly in my ‘good value’ band. My rule of thumb is that an average P/E below 10 is bargain territory, 10 to 14 is good value, and above 14 starts to move towards expensive.
Markets could continue to be volatile for the foreseeable future, but I see this as a terrific opportunity to snap up some core blue-chip stocks for a starter portfolio. Indeed, with the exception of technology firm Sage, I’d happily buy these Footsie heavyweights today.
Personally, I have Sage marked as a stock to avoid for now, because I believe the high P/E represents poor value for the company’s downgraded and uncertain earnings outlook. However, a number of my colleagues are keen on the stock — some rating it a top buy for 2019 — so you may want to look into the bull case.
Wide margin of safety
Sage aside, I see so much value on offer across the board that it’s hard to highlight any one of the nine stocks for special attention. British American Tobacco (BAT) is perhaps the most eye-catching, having the lowest P/E by some margin at 7.9 and with the second-highest dividend yield at 8.5%.
Tobacco stocks in general have fallen out of favour over the last year or two, but BAT has been hit particularly hard by adverse investor sentiment. It’s suffered not only from sector-wide concerns about regulation, but also from its much higher exposure than its peers to the US menthol cigarettes market. Regulators there are looking at banning menthol cigarettes. Another concern about the company is its current relatively high level of debt, following its $49bn acquisition of Reynolds American.
With investors shying away from the sector and the firm having company-specific issues to boot, its shares have fallen considerably further than those of its rivals. They’re currently 56% down from their all-time high of 5,643p in the summer of 2017. But I think the market’s being far too pessimistic about the company’s future.
The menthol cigarettes ban in the US is unlikely to happen for years, if ever, while the company’s debt-reduction plans look perfectly plausible to me. Moreover, with its share price having been hammered down to the extent it has, it offers a wide margin of safety against any future earnings setback.
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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, Sage Group, and Tesco. 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.