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My top buys for a FTSE 100 starter portfolio this summer

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. I see some good value on offer for investors this summer.

The table below shows the 10 industry 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 (p) P/E Yield (%)
BAE Systems Industrials 495 10.6 4.7
British American Tobacco (LSE: BATS) Consumer Goods 2,749 8.4 7.9
GlaxoSmithKline Health Care 1,577 14.0 5.1
HSBC Financials 657 11.4 6.2
National Grid Utilities 836 14.2 5.9
Rio Tinto Basic Materials 4,881 10.2 6.2
Royal Dutch Shell Oil & Gas 2,581 11.0 5.8
Sage Technology 802 25.5 2.2
Tesco Consumer Services 227 12.8 3.7
Vodafone (LSE: VOD) Telecommunications 129 15.2 6.3

Before looking at individual stocks, let’s get a feel for overall value. The table below shows average P/Es and yields for the group as a whole for the last four quarters and seven years.

  P/E Yield (%)
July 2019 13.3 5.4
April 2019 13.3 5.5
January 2019 12.3 5.9
October 2018 13.3 5.3
July 2018 14.7 4.8
July 2017 16.4 4.6
July 2016 17.2 4.4
July 2015 14.4 5.2
July 2014 13.2 4.5
July 2013 11.9 4.6
July 2012 10.7 4.7

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 is little changed from last quarter and remains in my good-value band.

Accountancy software group Sage has by far the highest P/E at 25.5 and lowest yield at 2.2%. Many of my Foolish colleagues remain keen on the company, but I think the valuation is too high. Personally, I’d avoid Sage right now, but be happy to buy the other nine stocks for a FTSE 100 starter portfolio.

Pessimism overdone

British American Tobacco (BAT) is worthy of particular comment, in view of its single-digit P/E of 8.4 and group-leading dividend yield of 7.9%. Two summers ago, it was trading on a P/E of 17.6, with a 3.7% yield. The share price then was 5,234p, compared with 2,749p today.

Remarkably, BAT’s de-rating has come in the face of continuing earnings and dividend growth, and forecasts of 7% increases in both the current year and 2020. It seems investors are worried about the longer-term outlook.

Global volumes of traditional tobacco products are declining, there are uncertainties around how markets for newer products, like e-cigarettes, will evolve, and ongoing regulatory risk casts an ever-present shadow.

However, I think BAT’s P/E and yield reflect far too high a degree of pessimism. As such, I see the stock is attractively cheap.

Disappointing, but …

BAT has overtaken Vodafone at the top of the yield leader board since my April review. This is because the telecoms giant announced a rebasing of its annual dividend (to 9 eurocents from 15.07 eurocents) in its annual results in May. A disappointing, but not unexpected, move to support its balance sheet, with its €18.4bn acquisition of Liberty Global‘s operations in Germany and Eastern Europe expected to complete in the next few weeks.

The current share price of 129p is lower than it’s ever been in any of my quarterly reviews since I started writing these articles in July 2012. This means even the new lowered dividend provides an attractive 6.3% yield for buyers of the shares today. And while the P/E is currently relatively high at 15.2, I expect the strategic and financial benefits of the Liberty Global acquisition to help drive strong earnings growth in the coming years.

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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.