Investors have accepted equity investments as a sureshot way to earn higher returns than other investment classes and build wealth. History shows that well-managed companies with strong business models and exceptional products and services have the potential to become multi-baggers, a term used to describe companies whose share price has increased exponentially over time.
Identifying a multi-bagger necessitates a thorough understanding of the company’s operations, management quality, and overall financials. Exploring the inner workings of blue chip companies is one way to discover potential multibaggers. But why blue chip companies? Let us figure it out.
Table of Contents
- What Are Blue Chip Stocks?
- Features of Blue Chip Companies
- How To Identify Blue Chip Companies
- Are Blue Chip Stocks A Good Investment?
- Risks Related to Blue Chip Stocks
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What Are Blue Chip Stocks?
Mr Oliver Gingold, a Dow Jones News Service reporter, coined the term “blue chip” in the early 1920s to describe stocks that traded for $200 or more per share. He used this term to describe high-quality stocks that are thought to be safe and reliable investments.
The origins of the term “Blue Chip” can be traced back to the game of poker, where blue chips are typically the most valuable chips on the table. The term “blue chip” was coined in the early 1900s to refer to the deep blue-colored high-value poker chips that denoted the highest value and could be used to make the most significant bets.
Features of Blue Chip Companies
Some of their main features of blue chip companies are:
- They have a long history of stable and successful business operations.
- They have proven their mettle by weathering economic ups and downs.
- They are enormous and colossal in terms of the size and profitability of their businesses.
- They make money for themselves.
- They lavishly compensate their shareholders with regular dividend payments and consistent capital appreciation.
Blue chips also include behemoth companies serving as a barometer for their respective sectors or industries.
How To Identify Blue Chip Companies
Blue chip companies have few specific traits making it easier for investors to identify them. These include:
- High market capitalisation.
- Large market share for their product categories.
- Strong financials and a stable balance sheet with low or zero debt resulting in higher profits and dividends for shareholders.
- Stellar brand value because of their robust financial health, excellent products and services, and impeccable track record of business performance and social responsibility.
- Such companies are generally part of stock market indices like NIFTY 50, Sensex, and S&P 500.
Popular U.S. Blue Chip Stocks
| Companies | Market Cap |
|---|---|
| Apple Inc. | $2.35 Trillion |
| Berkshire Hathaway Inc. | $668 Billion |
| Coca-Cola Company | $256 Billion |
| Johnson & Johnson | $470 Billion |
Popular Indian Blue Chip Stocks
| Companies | Market Cap |
|---|---|
| Reliance Industries Ltd. | ₹ 15.00 lakh cr |
| Tata Consultancy Services Ltd. | ₹ 11.63 lakh cr |
| Infosys Ltd. | ₹ 5.70 lakh cr |
| Asian Paints Ltd. | ₹ 2.70 lakh cr |
Are Blue Chip Stocks A Good Investment?
Undoubtedly, blue chip stocks should be included in every investor’s core portfolio. Here’s why investing in blue chip stocks makes sense:
- Blue chip companies make large profits and distribute a large portion of those profits as dividends.
- Blue chip companies have large profit reserves that are regularly capitalized through bonus issues. Bonus shares supplement an investor’s existing holdings.
- Blue chip companies typically have a large pool of business cash flows. If they are not used for business expansion, they are usually used to buy back shares from existing investors at a higher price than the market price. Share repurchases increase earnings per share (EPS), effectively raising the stock price over a period of time.
- Because brokerages and research firms extensively research blue chip companies, their performance is easily predictable. As a result, there are few surprises in the business numbers, which reduces share price volatility. Hence, these companies are ideal for passive investors who do not intend to monitor their price movement closely.
- All investors, including domestic institutions, foreign investors, high net worth individuals (HNIs), and retail investors, prefer blue chip companies. As a result, they are widely held by investors and are highly liquid.
- Because these companies are mature and have established business models, they exhibit consistent growth, which is frequently reflected in the stock price. This results in consistent capital appreciation.
However, like any other stock investment where current and future estimated valuation matters, blue chip stocks must be evaluated on this metric before being added to the portfolio.
Before adding blue chip stocks to their portfolio, investors should be aware that not all of them can deliver on expected lines due to inherent shortcomings. A few of them are listed below:
- Reduced agility: Owing to their size and scale of operations, blue chip companies are typically less agile than their mid cap and small cap counterparts. In the event of any favorable catalyst emerging in the economy, the blue chip companies might not be able to respond swiftly and take advantage of the same.
- Lower returns than mid and small cap stocks: Blue chip companies are relatively more mature and deliverpredictable results. Given their size and scale, they tend to generate consistent returns, which is reflected in their stock price movement. They may not be able to compete with their medium and smaller counterparts, who are more agile and fast growing and have the potential to deliver exceptional performance, resulting in higher investment returns, particularly during bull runs.
- Obsolescence risk: History is littered with examples of blue chip companies with industry leadership positions succumbing to complacency by ignoring new market trends and technologies and allowing the risk of obsolescence to take over, eventually resulting in an obituary being written.
Kodak and Nokia are two well-known companies that suffered due to this risk. Kodak was once a dominant player in the film and camera industries, but its inability to adapt to the rise of digital photography ultimately led to its demise.
Similarly, Nokia was a market leader in mobile phones, but their complacency in the face of the android-based smartphone revolution caused them to lose market dominance.
Bottom Line
Overall, blue chip stocks remain popular investments for many investors. Portfolio managers around the world have favorable views of blue chip stocks. These stocks are often seen as a core component of a well-diversified investment portfolio.
Blue chip stocks can provide stability and consistency to a portfolio while offering potential long-term growth. They can be an attractive and rewarding option with careful research and a well-considered investment strategy.
