4 Blue Chips to Lead UK Stocks Higher

12/14/2012 10:00 am EST


If re-rated by the market, these cheap blue chips will have a dramatic impact on the FTSE-100, writes David O'Hara of The Motley Fool UK.

The FTSE-100 is a market cap-weighted index. This means that the price changes of large companies such as Vodafone (London: VOD) and Royal Dutch Shell (London: RDS.B) have a bigger effect than smaller blue chips such as G4S or Pennon.

In the coming year, this could have a huge impact on the blue-chip index. That's because, in my opinion, four of the FTSE-100's five largest companies are very cheap right now. Apart from the depths of bear markets, I cannot recall a time when so many of the UK's largest companies have all been so attractively priced at the same time.

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1. Royal Dutch Shell
Shares in Shell currently trade within a few percent of their low for the year. In the last 12 months, shares in Shell have fallen 7.5%. That's almost a mirror of the FTSE-100's performance: the FTSE has increased 7.2% in the same period.

Although Shell's share price has disappointed, its yield is far higher than average. Shell is expected to yield 5% for 2012, rising to 5.1% in 2013.

On a forward price-to-earnings (P/E) ratio of 8.3 times expected earnings for the year, the shares are cheaper than most FTSE 100 stocks. The expected growth in 2013 makes the shares look even more attractive. Consensus is for the company to make earnings per share (EPS) of $4.45 in 2013. At today's price, that equates to a 2013 P/E of just 7.9.

2. BP
For the last two years, investors analyzing BP have been preoccupied with two issues: the Gulf of Mexico disaster and the company's joint-venture in Russia.

The 2010 Macondo disaster in the Gulf of Mexico cost 11 men their lives; it also cost BP billions of pounds. These problems were further compounded by disputes between BP and its partners in the TNK-BP joint-venture in Russia. In recent years, Russia has become a key part of BP's operations.

BP is near to closing the chapter on these massively damaging incidents. Only a few more cases remain in relation to the Gulf spill. In October, BP announced it had resolved the dispute with its Russian partners and entered an agreement with Russian state oil company Rosneft.

BP is expected to pay 38 cents in dividends for 2012-that's a 35.2% increase on the 2011 payout. The dividend is forecast to rise another 10.9% in 2013.

If BP can restore dividends to the level they were at before the Macondo disaster, investors buying now would get an 8.3% yield.

HSBC hit the news this week on receipt of a $1.9 billion fine for money-laundering offenses. That was more than the market expected. Yet it didn't stop the shares hitting a new high.

Shares in HSBC are currently trading at their highest since May 2011. However, it is possible that the shares are still cheap.

At the current level, HSBC trades on a forward P/E of 11.3. That's a considerable discount to the market average. Furthermore, significant earnings growth is expected in 2013. Analysts expect that next year's EPS will be 12.4% ahead of what the bank will make in 2012.

HSBC also pays a chunky dividend. At today's price, the shares are expected to yield 4.3% this year, rising to 4.7% for 2013.

4. Vodafone
Vodafone shares currently trade within a few pennies of their low for the year. The recent interim results for the company revealed large Eurozone writedowns.

While the shareholder dividend was increased, it was announced that there would be no special dividend payment this year. Instead, Vodafone announced a planned ?1.5 billion ($2.42 billion) share buyback.

This annoyed some investors on our discussion boards. Shareholders were unhappy that Vodafone was using cash to buy back shares rather than increase its dividend.

I'm more sanguine. First, Vodafone already pays a large dividend that has been increasing. Second, buying back shares means that Vodafone can increase its per-share dividend in future without having to increase the cost of the dividend (as fewer shares will be in issue).

I'm happy to take an increased dividend and let Vodafone to mop up any loose stock, especially as this has the effect of increasing my holding in the company. There is also the possibility that the share buyback will lead to a sharp, short-term rise in Vodafone's share price.

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