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. I’ve been saying for a while I think there’s good value in most of these titans. This quarter is no different, and I’ll explain why shortly.
First, the table below shows the companies’ individual valuations based on forecast 12-month price-to-earnings (P/E) ratios and dividend yields.
|Industry||Share price (p)||P/E||Yield (%)|
|British American Tobacco||Consumer Goods||2,897||8.4||7.7|
|Rio Tinto||Basic Materials||4,006||8.3||7.8|
|Royal Dutch Shell||Oil & Gas||2,300||10.2||6.7|
|Sage (LSE: SGE)||Technology||662||20.8||2.7|
The average P/E of the group is 13 and the average dividend yield is 5.5%. As you can see from the table below — which puts the current group rating into a historical context of the last four quarters and eight years — the P/E and yield have been within a fairly narrow range since this time last year, apart from a material dip into cheaper territory in my January review.
My rule of thumb for the group 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. At 13, we’re in my good value band.
If I were looking to set up an instant starter portfolio today, I’d happily buy these industry heavyweights — with the exception of one. Let me explain the exception, before commenting on the other nine.
I’ve been concerned for some time that the market has been overvaluing accountancy software firm Sage. I think there’s been overestimation of the ‘stickiness’ of its customers and ability to attract new ones at premium prices, and underestimation of the keen pricing and allure of the offerings of competitors.
In short, I believe the company has been valued for higher revenue growth, profit margins and return on equity than it’s likely to deliver.
At the time of my last quarterly review, the shares were trading at 802p and the P/E was 25.5. The shares are now 17.5% lower at 662p and the P/E has come down to 20.8. The reason for this is a profit warning in July in which management said revenue growth in the first nine months of its financial year had disappointed, and that profit margins would be at the lower end of its previous guidance.
In my view, fair value for Sage is a sub-20 P/E. It’s getting closer, but isn’t there yet, so I’m content to avoid this stock for the time being.
With the exception of Vodafone on an elevated P/E of 18.1, all the other stocks are trading on multiples between 8.3 and 14.3. The two trading on 14.3 are stocks in defensive sectors — GlaxoSmithKline and National Grid — which I think merit a somewhat higher P/E than average.
Vodafone’s shares are up 21% since I highlighted the value I reckoned they offered in my last quarterly review. Despite the rise and the now-high-teens P/E, I still see decent value, due to the company’s demerger plans for its towers network and longer-term earnings outlook. As such, I’d be happy to buy it today alongside the other heavyweights, while continuing to hold off on Sage.
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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.