Top buys for a blue chip starter portfolio

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

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Keen-eyed regulars may have noted that accounting software group Sage has replaced ARM Holdings in the technology sector. ARM, which I highlighted a number of times as particularly good value at prices between 795p and 1,105p, has been bought by Japanese firm Softbank for 1,700p.

Before looking at which companies might be particularly good value today, let's get a feel for the overall value.

The table below shows average P/Es and yields for the group for the last four quarters and five years. (The averages exclude Vodafone, whose P/E has been anomalous since its $130bn sale of Verizon Wireless).

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 and above 14 is getting expensive. As you can see, the P/E is little changed from last quarter and is towards the expensive end of my valuation spectrum. This doesn't mean the group of companies can't deliver a good return for investors, just that it could take longer to achieve than if the stocks were bought at a lower valuation.

Individual value

The little-changed group P/E from last quarter masks numerous relatively extreme changes in share prices, and earnings and dividend forecasts, at individual company level. This was due to the Brexit vote, which included the dramatic fall in sterling suddenly making the UK's biggest dollar earners more attractive and the Bank of England base rate cut, and a new bout of quantitative easing, compressing bond yields and adversely affecting sentiment towards companies with large pension deficits.

These sharp dislocations, or distortions, together with uncertainties about the different implications of Brexit for different industries and companies, make this a difficult time to judge where value lies.

However, our motto here at the Motley Fool has always been 'Keep Calm and Carry On Investing' -- through good times and troubled times -- as this gives you the best chance of growing your long-term wealth.

When earnings forecasts are as volatile as they currently are, the dividend can be a useful valuation marker.

Two to consider

Royal Dutch Shell, with the highest yield of the 10 heavyweights at 6.9%, is certainly worth considering. But I'm going to highlight HSBC at 6.4% .

In addition to its attractive yield, HSBC also has the lowest P/E at 12.6. This global giant's diversified business model and geographic profile provide a measure of resilience in difficult market conditions, and in its latest half-year results, management reaffirmed its commitment to maintaining the dividend, as well as announcing a share buyback programme.

Over the long term, HSBC's exposure to emerging markets should provide a tailwind for growth, although countries such as China are likely to go through spells of difficulty at times.

Five best buys

The Motley Fool's leading analysts have been scouring the market to identify the FTSE 100's highest quality powerhouses. Our experts have narrowed the field down to five companies they believe will deliver top-notch returns.

You can read all about these blue-ribbon blue chips in this exclusive FREE report. It comes with no obligation, simply click here now.

G A Chester has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended HSBC Holdings, Rio Tinto, and Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.