Do you have Blue Chip Stocks in your portfolio?
Every prudent market participant adds Blue Chip Stocks in their portfolio. These are the shares of the most prominent company in the market with a reputation for reliability, financial stability and quality. Blue Chip companies are generally market leaders in their segment and have a large market capitalization. They are the most famous stocks to buy in the stock market because of their long track records of stable earning or paying dividends.
In this article, we will understand the true meaning of Blue-Chip stocks and guide you in picking the right blue-chip stock.
So, let’s dive into it.
What are Blue Chip Stocks?
Blue-chip stocks are the shares of the most prominent company in the market with a reputation for reliability, financial stability and quality. Blue Chip companies are generally market leaders in their segment and have a large market capitalization. They are the most famous stocks to buy in the stock market because of their long track records of stable earning or paying dividends.
Investors prefer blue-chip stocks because of their stable income, increasing and consistent dividends and protection against inflation. During recessions, investors mostly invest in blue-chip stock to protect their investment, because blue-chip stocks can survive in a crisis.
Benefits of Blue-Chip Stocks
Blue-chip stocks are believed to be a safe harbour during an economic recession. Some of the companies listed on the Nifty50, such as HDFC Bank, TCS, Reliance Industries Limited, have to get through the economic slowdown over the years because of their strong financial statement and best management teams. Blue Chip stocks businesses are capable of buying out weak companies during a crisis, which further improve their position in the market.
An amateur investor focuses on investments that will give them quick money, whereas, experienced investors as well as an institutions like a sovereign fund and mutual fund focuses on establishing sustainable income for the coming time and protecting their money with stable investment, even though the investment will offer a moderate return.
How to choose Blue Chip Stocks for your portfolio?
Many investors want to invest in Blue Chip stocks but struggle to do so.
Here are some of the things which will help you in identifying the best Blue-Chip Stocks for your portfolio:
The blue-chip companies have a large market capitalization and are leaders in their sectors. Based upon your capital and investment preference, select the sectors in which you want to invest your money and look for the leading companies through market capitalization.
Income of the company
Check the income of the company in the last five to ten years and during both economic boom and bust. This will give a clear image of the company’s performance over the years. Generally, companies with a large market share will have higher income, so you can check the industry’s leading companies and compare their incomes.
Return on Equity
Checking the Return on Equity ratio of the last five to ten years helps investors to identify companies which have higher profitability as compared to shareholder’s equity. It is significant to know that each sector has different ranges of normal ROE. In comparison with the competitors, if a business has a better ROE, then it shows that the business is using shareholder equity much better than its competitors to generate profits.
Return on Assets
Investors use the Return on Assets ratio to identify the company that is competently using its assets to generate good returns.
In contrast to ROE, ROA considers the company’s debt as well. Although profitability is integral in identifying a good blue-chip stock, the ability of the management to utilize the resources of the company while securing good profitability is an indication that the company can tackle various economic disruptions.
Compare Piotroski Score
If you are an amateur in the stock market, then you might not have heard about the Piotroski score or the F- score.
The Piotroski score is predefined to evaluate the financial power of a company. It considers the following nine feature of a company’s financial statements:
- Positive Net Income of the company.
- Positive Return on Assets (of the current year).
- Positive Operating Cash Flow (of the current year).
- The quality of earnings (means Operational Cash Flow > Net Income).
- Decreased Leverage (Long-term Debt Ratio in the current year < previous year).
- Increased Liquidity (Current Ratio in the current year > previous year).
- No Dilution (No new shares issued in the current year).
- Gross Margin of the current year > previous year.
- Asset Turnover Ratio of the current year > previous year
The ideal F-score is 9. A higher F-score denotes financial strength of the company. Generally, a score of 6 and above is considered to be a good score. In the economic recession, the F-score of most of the companies from the sector will be low.
Intrinsic Value of a stock
Majority of the investors assume that the market capitalization of a business is its market value. This is the wrong approach. Since the market cap depends upon the current market price, investors pay for the stock but not the value of the company. Also, the price of a stock is determined on a range of factors like the demand or supply, social, political, and other macroeconomic factors.
While selecting blue-chip stocks for their portfolio, a majority of investors just check the top five companies in a specific sector. Yet, looking at just the market capitalization can be dangerous.
Don’t forget, the market value of a company is its true worth.
Let’s understand this with the help of an illustration:
Let’s say that the price of new jeans is Rs. 2 thousand. However, due to an increase in demand, it is being sold at Rs.4 thousand. If you purchase the jeans at Rs.4 thousand, then you are buying at available prices but the jeans are not worth the money. On the other hand, if the jeans are not in demand, retailers might offer it at a discount for Rs.1 thousand. In this case, if you buy the jeans, then you get twice your money’s worth.
Likewise, if you will buy a stock at a price more than it's worth, then you have to depend upon the continuous rise in the price of the stock to gain. Nonetheless, if you will buy an under-valued stock of a company, then your chances of making profits increases.
Blue-chip stocks are the stocks of the esteemed value in the stock market. Their proven track record gives them this stature.
The stocks of Blue-chip businesses are very sound, which makes them market leaders in their respective industries.
If one wants to start investing in the stock market with less risk, then blue-chip stocks are their best starting point. SEBI also recommends portfolio diversification to reduce risk.
However, investors must remember that it is also important to identify and buy undervalued blue-chip stocks.