Have you ever played a game of poker ? If yes, you could very well relate the term Blue Chip used in Poker to the term Blue Chips used in the world of investing. In a basic game of poker, there are three types of betting discs – white, red and blue. White have the lowest money denominator, while Blue have the highest value. Hence Blue Chips are high value denominated playing currencies.
In the world of investing, blue chips relate to similar kind of assets. A well established and reputed company is often classified as a Blue Chip Company. In Indian markets, examples of such companies will include the likes of Reliance, ITC, Hindustan Lever, Hero Honda, etc. These companies have gone through the test of time and have a tested business model, consistent growth trajectory which adds to an investor’s trust.
Traits of a Bluechip Company
Generally most of the blue chip companies have followed similar traits :
1. Diversified Product lines– They have multiple business lines to diversify the risk of failure of any one business line.
2. Multiple geographies – operate in and outside India across different countries. This could be organic growth or by acquiring companies in different locations
3. Big balance sheets – There is no definition which drives a Bluechip status by size of balance sheet. However, large companies have large asset bases. The top 50 companies in India have asset sizes greater than Rs. 30,000 crores (source moneycontrol.com)
4. Market Capitalisation – This is a more objective and transparent way of looking at Bluechips (also called as Large Cap stocks). Market Capitalisation is a product of number of shares of a company and its current market price per share. Top 50 companies have a market capitalisation of greater than 24,000 crore. Largest company is TCS with a market cap of 355K crores, followed by Reliance (275K crores) and ITC (264K crores) (source moneycontrol.com). While balance sheet size relatively grows steadily, the market cap keeps on fluctuating with stock prices. While the total market capitalisation of all companies (around 4000 companies) listed on Bombay Stock Exchange is approx 6300K crores, the top 50 companies have a combined market cap of approx 4000K crore. In summary, 1.25% of the total number of companies listed on BSE command 63.5% of the market capitalisation.
5. Better Finances – As an after maths of better goodwill owing to larger asset base, Bluechips tend to command higher respect in financial markets and hence garner more finances. And it is so true – money makes money ! If you have finances at your back pocket and good talent to drive business plans, then a business venture has a higher probability to succeed.
Can Blue Chips be blindly invested in ?
You may have heard the saying ‘all that glitters is not gold‘. Same holds true with blue chips. Larger companies does not necessarily mean good business models and better future growth trajectories. If the management has not been upto the mark and has been taking excessive risks, makes ‘too big to fail’ concept a shame. The financial crises showed so many such big business houses going bankrupt or reaching on the verge of bankruptcy. A few of such reputed names globally in the recent crises are :
1. Banking Industry : Royal Bank of Scotland, Citibank, Lehman Brothers, Merrill Lynch, MF Global
2. Automobile – Ford, General Motors, Chrysler
3. Telecom – Blackberry is in shambles and has finally put itself on sale in 2013
4. Airlines – American Airlines, United Airlines and now the most recent one Kingfisher airlines.
The idea is not to scare you, but to make investors aware that research is of paramount importance irrespective irrespective of how large a company is.
Comparison between a Blue chip and a Mid-Cap company
Often things become even more glaring if compared against a contrast. Hence we have a comparison against a few key indicators between a large cap blue chip company and a mid cap company. For this analysis we have chosen HDFC Bank (HB) as a Blue chip and Yes Bank (YB) as a Mid Cap company. Both the companies belong to the private sector banking industry. The data is sourced from www.edelweiss.in as of 13 Aug 2013.
Valuation Comparison
A blue chip company commands higher valuation owing to better stability and consistent growth. You would notice a few of the ratios below. The important ones being :
1. PE or Price Earning ratio. It is very evident that HB around 3 times more expensive than YB.
2. Price to Book ratio is also denoting that HB’s price is 3.92 times of the book value of its assets compared to YB’s 1.87 ratio.
Growth Comparison
This is a tricky one. Bluechip companies may enjoy a stable growth over a period of times. The growth rate may not be as high as midcaps which are in rapid growth pace. Having said that, it could even be reverse. In our example HB’s growth in sales and profits is less than YB. This sounds reasonable as YB is in a rapid growth phase and once it matures, its growth rate would stabilise. [CAGR means compounded annual growth rate, EBITDA means Earnings before Interest, Taxes and Depreciation].
Income Statement Comparison
A blue chip company has larger revenues and profits compared to mid caps. In the data below you would notice that Sales of HB is over 4 times more than YB and its profit is over 5 times of YB.
Balance Sheet Comparison
This is ought to be a stark contrast. A blue chip being a much fatter organisation has assets which are multiple times of a mid cap company. HB has 4 times more assets than YB, 7 times more networth, 3.8 times more debt. Though it is interesting to note that the book value per share of YB is higher than HB. This is more of a red-herring. If a company has less number of shares, its book value can be higher.
It is a good investment strategy to invest in bluechip companies or mutual funds investing in such companies as it adds stability of growth to the portfolio. However, investors need to be careful in selecting such companies to avoid ending up trapped with poor performing so called big companies.
Any names of companies mentioned in this article do not represent a buying / selling recommendation. They are just used for illustrative purposes. The data used is at a point of time and will change on a day to day basis based upon company’s performance and the movement in the stock prices.