How do the UK's 10 industry giants shape up as a starter portfolio?
Here at The Motley Fool, we've long extolled the virtues of low-cost index trackers as a one-stop shop for equity investment. Tracker funds simply replicate an index, such as the FTSE 100 (UKX) or FTSE All-Share.
However, index tracking isn't everyone's cup of tea. Some people prefer to invest directly in the shares of individual companies.
Shares vs trackers
One reason some investors prefer shares is because of the industry imbalances within the FTSE indices. Some industries are more heavily represented than others.
At the broadest level, there are 10 industry sectors in the official classification. The table below shows the proportion of these industries within the FTSE 100 (and, thus, a FTSE 100 tracker).
|Oil & Gas||19|
As you can see, the imbalances are quite substantial. Oil & Gas, for example, represents one tenth of the 10 industries, but makes up almost a fifth of the index. At the other end of the scale, Technology also represents one tenth of the industries, but makes up just one hundredth of the index.
Oil & Gas, Financials, Consumer Goods, and Basic Materials (mainly mining) and are all 'overweight', while the other six sectors are all 'underweight'.
Investors in trackers have to live with the sector skews of the index. But investors in individual companies are free to choose the industries they invest in and the weight they give them.
Some investors argue that, because we can't know how the different sectors will perform in the future, 'equal weighting' between industries is the most logical approach.
A starter portfolio
From time to time, I take a look at the largest FTSE 100 companies in each of the 10 industries to see how they shape up as a potential 'starter' portfolio.
I did this at the weekend, and 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.
|Company||Industry||Share price (p)||P/E||Yield (%)|
|HSBC (LSE: HSBA)||Financials||561||9.0||5.2|
|Royal Dutch Shell (LSE: RDSB)||Oil & Gas||2,225||7.6||5.0|
|BHP Billiton (LSE: BLT)||Basic Materials||1,806||7.6||4.3|
|British American Tobacco (LSE: BATS)||Consumer Goods||3,242||14.6||4.5|
|Tesco (LSE: TSCO)||Consumer Services||310||8.8||5.0|
|GlaxoSmithKline (LSE: GSK)||Health Care||1,447||11.4||5.3|
|Vodafone (LSE: VOD)||Telecommunications||179||10.9||7.4|
|Rolls-Royce (LSE: RR)||Industrials||858||14.2||2.4|
|National Grid (LSE: NG)||Utilities||676||12.4||6.1|
|ARM Holdings (LSE: ARM)||Technology||506||32.2||0.9|
Excluding tech share ARM, the companies have an average P/E of 10.7 and an average yield of 5.0%. The numbers were 9.8 and 5.2%, respectively, when I last carried out this exercise in October 2011.
So, the group is rated a bit more highly today than it was nine months ago. However, I think it still veers towards the value end of the spectrum, because my rule of thumb for this group of nine is that an average P/E below 10 is firmly in 'good value' territory, while a P/E above 14 starts to move towards expensive.
In other words, it seems to me that the market is still offering a good opportunity to buy a blue-chip bedrock of industry heavyweights for investors who are looking to embark on building a diversified portfolio of UK equities.
At the individual company level, oil major Shell and miner BHP Billiton, are both on an eye-catching low P/E of 7.6, as jittery investors worry about global -- and particularly Chinese -- demand for natural resources. My Foolish colleague Roland Head has been eyeing up the mining sector recently, while I thought Shell looked good value after its first-quarter results a couple of months ago.
Supermarkets have also been out of favour of late. None more so than Tesco after it issued a profit warning earlier this year. Despite the current low P/E of 8.8, I don't personally rate Tesco a buy, because I believe there's a good chance we could see the shares below 300p at some point.
However, Tesco is rated a bargain at the current level by plenty of my Foolish colleagues -- and also by US investing legend Warren Buffett. The Motley Fool special report "The One UK Share Warren Buffett Loves" gives you the full story on Buffett's Tesco investment. You can download your copy right now for free.
For investors who are particularly interested in dividend income, Vodafone catches the eye on a standout yield of 7.4%. I've been singing Vodafone's praises as an income share for a number of years, while my Foolish colleague David O'Hara has recently described the company as the best large-cap income opportunity he can recall!
Finally, if you are in the market for blue-chip dividend shares, do grab the opportunity to find out where dividend supremo Neil Woodford is investing today? All is revealed in this free Motley Fool report – "8 Shares Held By Britain's Super Investor". You can download your copy right now and, as I say, it's 100% free.
Want to learn more about shares, but not sure where to start? Download our latest guide – "What Every New Investor Needs To Know" – it's free. The Motley Fool is helping Britain invest. Better.
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> G A Chester does not own shares in any of the companies mentioned in this article.