A beacon of hope in volatility, Blue Chip company stocks can fortify our portfolios
By: Tavaga Research
When times are tough, the most common advice on the street is to put our faith in Blue Chip stocks. Blue Chip stocks in India are synonymous with large-cap company stocks.
There are plenty of market-linked products but Blue Chip shares or large-cap equity shares are often the most coveted instruments of them all.
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What does it mean to be a Blue Chip stock?
The term ‘Blue Chip’ to describe stocks originated in the US, a play on the high-value pieces on a poker (gambling) table. A Dow Jones employee, Oliver Gingold, is said to have coined it way back in 1923, to apply to stocks that had been trading at $200 or more a share in those days.
In the early 20th century, Blue Chip stocks primarily meant high-priced stocks. But with time, the meaning was modified. If at first, it was the Blue Chip share price determining the status, now it is the inherent value of a Blue Chip share (fundamentals).
Stocks of companies that weather market volatility and economic slowdown, ie. outperform other stocks in difficult times, often qualify as Blue Chip.
Companies that are this resilient usually have a large market capitalization, diversified operations, often with a worldwide presence, financial stability to be able to afford regular dividend payments to its shareholders. These characteristics are achieved with time.
Blue Chip stocks or Blue Chip shares are the most commonly used terms, but by association, Blue Chip can also be used for the companies whose stocks are being considered or even investment funds that track Blue Chip shares.
Common parameters for Blue Chips
It may be difficult for the retail investors to put their finger on what defines a Blue Chip company. But we could look to the most commonly used parameters for help:-
- Market capitalization – The total market value of the company, mathematically represented as:-
Market Capital = Price of share*Number of shares outstanding in the market
For example, companies with a market capitalization of $5 billion or more or the 100 largest companies in a country are included in the Blue Chip stocks list.
- Return on equity (RoE) – Returns earned by the stocks’ equity investors are more stable than returns from other companies. Although the payment of dividends is not compulsory, still companies like TCS and Apple pay regular dividends to their Investors, creating a steady source of income for investors and goodwill in the process.
- The debt-to-equity ratio (D/E) – The proportion of debt compared with that of equity in a company’s books. Debt is the number of funds borrowed and carries a regular payment of interest to the debtors of the company. On the other hand, equity is the amount of the owners’ funds that is deployed in the company, and the company is not required to pay its equity (share-) holders (dividends). A company is generally considered Blue Chip if its D/E is equal to or less than 1.
- Bond ratings – Bonds are scored by rating agencies such as Fitch and Moodys on the basis of their credit-worthiness. ‘Investment-grade’ bonds have the highest ratings, and this is an indication of a Blue Chip company.
- Liquidity – Stocks which are not much affected by large buy or sell orders (at the bourses where they are traded) are considered as liquid stocks. Liquidity in the market means there is enough scope in the market for trading the stock, without leading to its price (and hence, the company’s market cap value) to fluctuate. Stocks with the highest liquidity are preferred by large investors and are considered as Blue Chip stocks.
- Revenue growth – The revenue of the top MNCs (multinational companies) have a stable growth trajectory. Before terming a company as Blue Chip, investors should look at the revenue growth of the company. Companies with consistent revenue growth may make the cut.
Which are the blue-chip companies?
Global giants such as Coca-Cola, Microsoft, TCS, Infosys, Britannia, and Nestle are a few examples of companies considered to be Blue Chip or large-cap stocks.
Penny vs growth vs Blue Chip stocks
In India, penny stocks are those which are of some of the lowest value, not just in terms of their price but also in their fundamentals. Low market capitalization and sketchy dealings are other characteristics of these low-on-accountability companies. The riskiest of stocks, some of them may generate abnormal returns if they start to fare well. These are usually the micro-caps or small-caps in our markets.
Growth stocks are of those companies which plough back their profits into the business, instead of paying dividends to equity shareholders. Such companies have been around for some time but are not as well-established as Blue Chip companies. They straddle the middle ground in a market and can easily be identified by their other name — mid-caps.
Why are Blue Chip investments preferred?
As we said earlier, the standard response in times of stress is to lay store by large-caps or Blue Chips.
If all of their parameters are to be considered, Blue Chips are the ones with the lowest risk to reward ratio.
Blue Chips are low on surprise gains, as their returns are steady and in relatively smaller increments (not in absolute value). They are also costly to bag, ie. their prices are some of the highest on an exchange.
But stress in a market often means volatility, feeding an ‘anything-can-happen’ vibe, where it becomes difficult to ascertain if we will lose or gain.
If the rewards in the form of unexpected gains are low for Blue Chips, then so is their risk of unexpected losses. In volatile time, investors of all appetites can depend on Blue Chips to still post-growth and maybe, even give them dividends.
Blue Chips companies have diversified operations that mitigate risks in a sector, helping investors add to their wealth from their equity shares.
But not without risks
Low risk can never mean no risk. There have been instances, even in India, where so-called Blue Chip companies have turned turtle.
Reliance Communications used to trade at Rs 792 in early 2008, and its stock’s market price in 2020 is Rs 0.85, in the range of penny stocks.
Prudent research and even a consultation with an investment adviser can not be underlined enough when it comes to investing directly in equity stocks.
How to invest in Blue Chip companies?
There are a number of ways to make Blue Chip investments. We enumerate the important ones:-
Direct investment — We may invest in Blue Chip stocks by buying them from the open stock market (secondary market) at market price.
A return of less than Rs 1 lakh on equity shares does not attract tax, while a profit of more than Rs 1 lakh attracts an STCG ( Short-term Capital Gain) tax of 15 percent if the investment is sold within a year of being bought. If sold later, then the LTCG ( Long-term Capital Gain) tax of 10 percent is levied.
Pooled investment — We may opt for investment Blue Chip funds which track Blue Chip stocks with the pooled money and distribute the earnings based on the units held by us.
There are mutual funds that track Blue Chip stocks such as SBI Bluechip Fund, Axis Bluechip Fund, and Mirae Asset Emerging Bluechip Fund.
The SBI Bluechip Fund is headed by Fund Manager Sohini Andani and its major holdings include stocks of HDFC Bank, ITC, and L&T.
The Axis Bluechip Fund is headed by Fund Manager Shreyash Devalkar and its major holdings include HDFC Bank, Kotak Mahindra Bank, and Reliance Industries.
The Mirae Asset Emerging Bluechip Fund, co-managed by Neelesh Surana and Ankit Jain, has major holdings in HDFC Bank, ICICI Bank, and SBI, among other stocks.
As with all investment funds, we should avoid duplication of securities. In the Blue Chip funds mentioned above, some of the majorly-held stocks are common. As a savvy retail investor, it should be our aim to diversify our portfolio, and not buy into similar funds. It also helps to invest for the long term (at least for five years).
In passive investing, exchange-traded funds (ETFs) track Blue Chips in their own way, as well.
For example, we have the Kotak Nifty ETF which holds stocks of companies such as HDFC Bank, Reliance Industries, HDFC, ICICI Bank, and Infosys, which are all Blue Chips.
To Blue Chip or not
If we can afford to take on moderate risk in our investment portfolio, we may consider one with at least 50 percent comprising Blue Chip stocks or a Blue Chip fund. The rest may have a diversified spread of mid-cap and small-cap stocks to infuse that right dose of exponential growth prospect. To bypass market risks and inflation, commodities or ETF tracking commodity indices could also be made a part of our portfolios.