The Top Twenty Shares

Many analysts believe that the UK's biggest firms are going cheap. We look for value among the big guns.

The FTSE 100 index (alias the 'Footsie') measures the value of the one hundred largest businesses listed on the London Stock Exchange.

Obviously, the value (or 'market capitalisation') of each member of this index varies over time, based on the company's own business performance and prevailing stock-market trends. Hence, each quarter, the constituents of the FTSE 100 are reshuffled, with some smaller companies being relegated and replaced by firms promoted from the FTSE 250. (The FTSE 250 index tracks the value of the 101st- to 350th-largest listed companies.)

In the past year in particular, takeover bids and speculation (notably by cash-rich private-equity firms) has pumped up the shares of many mid-cap firms. Hence, at the lower end of the Footsie, there is a steady quarterly turnover, with firms popping into and dropping out of the index.

However, at the other end of the market, we find the UK's Goliaths or 'mega-caps', where very little changes. Indeed, the entire stock-market is dominated by perhaps twenty huge companies -- household names which tower over their rivals.

Allow me to show you just how impressively massive these businesses are. In June 2005, I penned this article, in which I went hunting for value among the UK's twenty largest companies. Repeating this exercise today, you can see from the following table that, apart from movement within the table, not much has changed in the intervening two years:

Our 'FTSE 20': the UK's twenty biggest listed companies

Source: Company Refs

There are two new entrants to the table: mining firm Xstrata and bank Standard Chartered; Shell Transport & Trading has been renamed Royal Dutch Shell; and National Grid Transco (LSE: NGT) and Unilever (LSE: UVLR) have fallen out of our top twenty.

When I carried out this exercise 23 months ago, the total value of the top twenty was £807 billion. Today, the figure stands at £968 billion, so the value of our mega-caps has grown by a fifth (20%) over the past two years. To me, that's a fairly decent return for investing in the relative safety of big blue chips.

Over the past two years, I've invested heavily in several of these big businesses, based on my belief that there is hidden value to be found among the mega-cap firms. Indeed, as followers of the Fool's value investor Stephen Bland (alias PYAD) will confirm, this style of value investing has a good track record in both fair and foul stock-market conditions.

In my previous article, I singled out shares in BT as being attractively priced, having a modest P/E (price-earnings ratio) and high yield (the income paid by shares). Since then, BT shares have risen from 219.5p to 309p today. This share-price growth of roughly two-fifths (41%) has comfortably beaten the wider stock market since June 2005.

Thanks to rising earnings and strong competitive positions, many analysts believe that the UK's biggest firms are still cheap today. Searching the above table for a candidate with a low P/E and above-average yield, my pick of the FTSE 20 for 2007 is Royal Bank of Scotland.

RBS is a well-managed, fast-growing global bank, but its share price has taken a knock since it trumped Barclays' bid for Dutch rival ABN Amro. In my view, the recent weakness in its share price represents an excellent opportunity to buy into this respected banking franchise at an attractive price. Thus, I recently added RBS to my wife's personal portfolio. Let's hope that big does indeed prove to be beautiful!

More: Invest in seven hundred companies at low cost with an index tracker.

Declaration: Cliff owns shares in GSK, HBOS, iFTSE 100, Lloyds TSB, RBS and Vodafone.