Which FTSE Mega Cap Is the Best Value Today?

LONDON -- The top five companies of the FTSE 100 index look cheap on the face of it: Their average price-to-earnings ratio is less than 10 and their average dividend yield is more than 5%.

But which super-heavyweight offers the best value today?

The data in the table below is based on current-year forecasts. The companies have year-ends of Dec. 31, with the exception of Vodafone (LSE: VOD.L), whose year-end is March 31.

As you can see, there's quite considerable variation in the earnings and dividend numbers of the individual companies.

Let's have a look at each firm in turn.

Shell out on Shell?
Oil supermajor Royal Dutch Shell's revenue in the last 12 months was a staggering $474 billion -- bigger than Sweden's gross national product, and putting it second only to U.S. oil giant ExxonMobil ($483 billion) as the world's biggest company by revenue.

Current earnings forecasts for 2012 for oil companies are lower than they were a year ago, though the data provider I use doesn't have a number in the case of Shell. The supermajors tend to track the price of crude oil pretty closely, and oil prices have recently bounced back strongly after a big dip in the April-June quarter.

While prices can be volatile in the short term, big oil companies should provide a hedge against inflation in the long term. With a P/E of 8.5 and with a decent dividend yield of 4.8%, Shell looks attractive to me.

Bank on HSBC?
Five years after the onset of the financial crisis, banks are still working their way through their losses and writedowns. It's what banks do when overinflated assets go pop -- and, historically, it usually takes longer than many people expect to let the air out of the balloon.

Analysts were considerably more optimistic a year ago about HSBC's earnings for 2012 than they are today: Forecasts have been downgraded by 16% over the year.

With the latest financial crisis being particularly deep, Europe's sovereign debt issue rumbling on, and banks seemingly having made an art out of shooting themselves in the foot, I expect it to be a few years yet before book value correlates to the true underlying value of the assets. As such, HSBC's P/E of 9.7 doesn't particularly appeal to me. I find it easy to envisage the shares dipping below the current 561 pence at some point before banks see light at the end of the tunnel.

Lock in Vodafone?
Mobile phone colossus Vodafone has become something of a utility-like cash cow in recent years as phones have transitioned from luxury item to a more-or-less essential product. Vodafone has seen weakness in southern Europe of late, but its global geographic diversity and particularly strong demand in emerging markets should drive growth for many years to come.

In keeping with Vodafone's utility-like status, the P/E is reasonable at 11.5 rather than low, but you are getting forecast earnings growth of 8% this year compared with negative growth for HSBC and the two oilies.

You're also getting a whopping forecast dividend yield of 7%. The yield needs some explanation. Vodafone has been delivering on a commitment set a few years ago to increase its dividend by at least 7% a year up to and including 2013. The company expects to pay an ordinary dividend of at least 10.18 pence this year. That equates to a yield of 5.5%, which itself is comfortably the best of the mega-cap quintet.

However, Vodafone also paid a special dividend of 4 pence per share last year, so this year's forecast yield of 7% implies another special with the analysts' consensus being for 2.8 pence. The special dividend comes from Vodafone's 45% stake in U.S. firm Verizon Wireless, which is majority-owned by Verizon Communications. The parent company needs cash flow from Wireless to fund its own dividend, and as long as that remains the case, Vodafone will also see a bumper inflow of cash.

Buy BP?
The U.K.'s second-largest oil company, BP, has the lowest P/E rating of the FTSE's top five companies at 7.6. It also has the lowest yield -- 4.6% -- after it suspended and then rebased its dividend in the wake of the 2010 Deepwater Horizon disaster.

How much BP will ultimately pay in compensation for that blunder is a "known unknown," while the company's joint venture in Russia, TNK-BP -- which accounts for a third of the group's production -- has proved lucrative so far, but problematic and potentially vulnerable to adverse political intervention.

While BP's P/E is low, known unknowns and political risk can't be precisely quantified, so it's difficult to say whether these things are under-, over-, or accurately reflected in the share price. On the earnings multiple, you're paying just one year less for BP than for Shell. I'd want a bigger discount than that under the circumstances, so the way I see it, Shell is relatively a better value.

Go for Glaxo?
Pharma giant GlaxoSmithKline is forecast to deliver earnings growth of a modest 2% this year -- better than the negative growth of three of the top five FTSE firms, but behind Vodafone's 8%. Despite the lower earnings growth, Glaxo has a higher P/E than Vodafone -- 12.3 versus 11.5 -- and its yield of 5.1%, while very decent, is not in the same league as Vodafone's 7%.

There's not too much wrong with Glaxo. Its P/E rating isn't altogether unreasonable in absolute terms and its yield is good, but in relative terms, I just feel that one or two of the others offer better value.

Pick of the bunch
Overall, on a historical basis, the leading companies of the U.K.'s elite FTSE index look cheap. Shell's valuation looks attractive, but, in these uncertain times, the pick of the bunch for me is Vodafone. The forecast ordinary dividend yield of 5.5% is excellent, but becomes fantastic with the special on top pushing it up to 7%. That's a great starting yield for anyone drawing an income, while reinvesting dividends should see the value of a shareholding compound nicely over time.

I'm not alone in liking Vodafone. The share is one of the biggest holdings of top City fund manager Neil Woodford, whose dividend stock picks have beaten the wider market by 305% over the last 15 years.

Woodford has been successful by ploughing his own furrow and investing very selectively. He likes Vodafone, but which other blue chip companies is he keen on right now? To find out, get yourself the exclusive Motley Fool report -- "8 Shares Held by Britain's Super-Investor" -- it's free. Simply click here and it will be in your inbox in seconds.

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