A Blue-Chip Starter Portfolio: Royal Dutch Shell Plc, HSBC Holdings plc And ARM Holdings plc

Every quarter I take a look at the largest FTSE 100 constituents in each of the index’s 10 industries to see how they shape up as a potential “starter” portfolio.

The table below shows the current 10 heavyweights and their valuations based on forecast 12-month price-to-earnings (P/E) ratios and dividend yields.

To get a feel for overall value, the table below shows average P/Es and yields at my quarterly review dates. The averages exclude ARM, with its typically elevated tech-sector P/E, and also Vodafone, whose P/E has been anomalous since its mega-sale of Verizon Wireless last year.

My rule of thumb for the companies — as a group — is that an average P/E below 10 is bargain territory, 10-14 is decent value, while above 14 starts to move towards expensive.

Today’s P/E hasn’t fallen as much as one might have expected, given the decline in the FTSE 100 over the summer. This is because, while share prices have fallen, earnings forecasts have also been lowered. Nevertheless, an average P/E of 13.7 suggests today’s “starter portfolio” is decent overall value.

The dividend yield of 5.6% is particularly eye-catching. Dividend forecasts haven’t been downgraded as much as earnings forecasts, which is why the yield is so high. You can see that the current P/E is only marginally different from its level in January, but that the dividend yield is considerably higher than January’s 4.8%.

I’ve mentioned this feature several times this year, suggesting that we could be in for a spell of little or no dividend growth from some companies — and maybe the odd dividend cut — to bring the yield and P/E back into a more normal relationship. Indeed, a couple of companies have already announced an intention to peg their dividends at the same level as last year for the time being.

Oil titan Shell has the highest yield of all at 7.7% and is one of the companies that has said it won’t be increasing its dividend this year. Nevertheless, because the yield is so high, Shell still looks an attractive investment. The P/E of 11.5 also indicates value, while the share price of 1,601p is lower than it’s been at any of my previous reviews. Of course, low oil prices are currently hurting Shell’s earnings, but everything points to good value in the shares for long-term investors.

Global banking giant HSBC has similar value credentials to Shell. The bank’s P/E of 9.5 is in bargain territory, the dividend yield of 6.7% is higher than its been at any of my previous reviews, while I have to go back to my October 2011 review to find the share price lower than today’s 503p. HSBC is out of favour with the market, because of the group’s large exposure to Asia and concerns about slowing growth in China. As with Shell, though, everything points to good value in HSBC’s shares for long-term investors.

Finally, ARM, the world-leading designer of energy-efficient microchips, may not appear obvious value at a P/E of 26.9 and a yield of 1.1%, but, as I mentioned earlier, technology companies tend to command higher ratings. ARM may be a giant, but it’s still increasing its earnings at a faster rate than many smaller “growth” companies. ARM’s P/E is currently lower, and it’s yield higher, than at any of my previous reviews (the P/E has been as high as 44.9 and the yield as low as 0.6%). There are concerns that ARM may not be able to increase earnings as fast as in the past, but I would say the downgrade in P/E already discounts that possibility, and so the shares appear good value.