he term "blue-blooded" is often used to describe a person of royal descent.
Blue chips - a term given to certain stocks - denotes the identical connotation in the stock family.
Blue chips are supposed to be the best stocks you can possibly own -- the crème de la crème of the stock market.
They are supposed to be solid, dependable stocks that will deliver good returns year after year to investors.
A few obvious ones that come to mind are Infosys, Wipro, Tata Steel and ITC.
What's great about them?
Blue chips are the darling of investors for a number of reasons.
- They have a large market capitalisation.
If the number of shares in a company is multiplied by its current price, the result is market capitalisation.
A large market cap indicates a highly liquid stock.
Liquidity refers to the ease with which an instrument can be converted into cash at a reasonable price. A stock with high liquidity means that individuals can easily buy and sell it as there are always sellers and buyers for these stocks.
And, it also indicates that large amount of shares can be bought and sold without significantly impacting its price. So even mutual funds and institutional investors can hold huge chunks of these shares and it will not have an adverse affect on the liquidity.
Blue chips are generally the most liquid stocks.
- Size does matter
They are among the largest companies in their respective sectors.
By virtue of their size, they are more stable than the smaller players. Hence, they are not very volatile. So, if you do not want a company showing a great performance in one year and plummeting the next, this one is your cup of tea.
This makes them a favourite with conservative investors.
Forever safe?
Not really. A blue chip today could become a dud tomorrow.
Remember, there is always a risk associated with stocks blue chip or not. Though the risk with a blue chip will be much less than the risk of a mid-cap or small cap.
In fact, the term blue-chip is derived from poker where the highest and most valuable chip is blue.
Got it? Stocks are a gamble. It is just that blue-chips are a safer bet.
How many of us remember that Bombay Dyeing once used to be a blue chip? Or Century Textiles?
On the other hand, some of the insignificant ones of yesterday are today's blue chips. Where was Infosys a decade ago?
The only constant in the market is change, and change has led, in recent times, to stalwarts like Hindustan Lever biting the dust. Conservative investors who believed that this multinational stock was one of the bluest of blue chips would have lost quite a lot of money.
How do you spot a blue chip?
As a practical definition, being included in the Sensex can be taken as a big step towards acquiring blue chip status.
Generally, a blue chip has a history of solid earnings, regular and increasing dividends, and an impeccable balance sheet.
One way of considering whether a stock is a blue chip or not---a method often adopted by long-term investors such as pension funds---is to decide whether a company is still likely to be at the top of its sector 10 years down the line.
If you're more or less certain of that, then day-to-day or even month-to-month fluctuations in the market won't bother you.
Should you invest in a blue chip?
In the current craze of everyone running to invest in a mid-cap or small-cap, this question does come to mind.
The answer is clear: of course you should.
Though chances are that you may make much more money investing in a mid-cap. That is because these are stocks that are usually low-priced because investors haven't yet discovered their potential.
To understand more on mid-caps, read Why mid-caps are hot.
Mid-caps have the potential to be tomorrow's blue chips.
But, then again, they may not. Hence, mid-caps and small caps carry a higher risk than blue chips. Also, their earnings are much more volatile and neither are they as liquid.
If you want to invest in shares but are not too savvy with the market, then blue chips are your best bet. Even if you want to invest in mid-caps and small caps, ensure that you have a few blue chips too to balance your risk.
But it's absolutely essential to monitor your investments and get out of those stocks that aren't doing well, regardless of whether they once had a reputation as blue chips.
And remember, it's not enough to be a good company---it must also be available at a decent price. To further your understanding on this, read How to spot a good stock.
During a market boom, prices are often ramped up so high that it isn't worthwhile to buy stocks for the long-term at those levels.
Don't be under the mistaken notion that whatever be the price of a blue chip, it is worth buying.
Illustration: Uttam Ghosh
