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

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’.

The table below shows the 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.

My rule 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 average P/E of 13.7 is unchanged from three months ago, suggesting the “starter portfolio” continues to offer decent overall value.

Royal Dutch Shell, Rio Tinto and HSBC particularly catch the eye with well-below-average P/Es and super-elevated dividend yields.

Over-supply in the oil industry has seen the price of oil collapse over the last 18 months from above $100 a barrel to below $30. Commentators are currently engaged in a game of dare on ever-lower predictions as they seek bragging rights for calling where the oil price will bottom.

Investors were paying around £25 a share for Shell before the oil rout began. The stock looks good value today for long-term investors at £13.50 on a P/E of 10.5 times. Sure, the price of oil, and Shell’s shares, could go lower in the near term, but buying a lot nearer the bottom of the cycle than the top should pay off handsomely over the coming decades.

Shell’s current forecast dividend yield of 9.1% may not be realised. Typically, we see dividend cuts when stocks trade with such an elevated yield for any length of time. But for the long term, Shell should generate plenty of cash and pay generous dividends.

The mining industry is also going through a period of over-supply. Rio Tinto is in a similar position to Shell, and my comments on the latter apply equally to the miner.

Rio’s shares traded at comfortably above £30 for most of 2014. At below £17 today, on a P/E of 11.1 times, this is another stock that could prove to be a long-term winner. Again, the dividend may come under pressure in the short term, with the yield on a par with Shell’s 9.1%.

Concern about growth in China, which is a factor in the current state of play in the oil and mining industries, is also impacting sentiment towards HSBC, with its considerable exposure to China and the wider Asian economy.

HSBC’s shares reached post-financial-crisis highs of over £7 during 2013, but have declined to under £5 today. The P/E is just 9.6 times and the dividend yield is 6.9%. Of course, a full-blown financial crisis in China would hit HSBC hard, but that’s the worst-case scenario. If China can muddle through its near-term issues and continue to move to a more Western-style economy in the coming decades, HSBC should flourish.