When you think of fundamentally strong and technically sound companies, what names usually pop up in your head? You aren’t wrong if you thought of Reliance Industries, TCS, Hindustan Unilever, or any trailblazer company with an enviable market standing that has proven to be a multibagger stock over the past few years.
Such well-established market leaders with stellar financial records that are easily recognisable among the thousands of companies on the stock exchange are known as ‘blue-chip companies’, and the stocks they issue are ‘blue-chip stocks’. The term ‘blue-chip’ derives from the game of poker where the blue-colored chips have the highest value.
This article delves into the meaning and popularity of blue-chip stocks and how you can pick the best ones.
What are blue-chip stocks?
Blue-chip stocks are the stocks of companies with an outstanding reputation. Such companies have huge market capitalisation, steady earnings, strong financials, usually pay attractive dividends to their investors, and have long-running market operations. Furthermore, blue-chip companies are typically market leaders or occupy a dominant position in their sector. They are resilient against adverse market conditions and continue to grow profitably even during periods of economic downturn.
Characteristics of blue-chip stocks
When you are looking for blue-chip stocks, you can use the following characteristics to identify them:
- Blue-chip stocks are large or very large-cap stocks. They are usually prominent market leaders or stock market giants in their respective sectors.
- Blue-chip companies have a long history of steady returns and consistent performance.
- Blue-chip companies are financially resilient with zero or negligible debt levels.
- Such companies have a track record of surviving economic slowdowns and show promising growth prospects.
- Blue-chip companies are typically diverse with multiple sources of revenue. This feature serves as a buffer against losses and operational setbacks.
- Most importantly, blue-chip stocks are stable, low-risk stocks and are ideal for investors with long-term goals.
How to pick the best blue-chip stocks?
By now it is clear that blue-chip stocks are one of the best additions for your portfolio. However, the bigger question is- how do you spot the best blue-chip stocks? Apart from the abovementioned characteristics, you must consider other metrics to choose the best blue-chip stocks for your portfolio.
Here are some parameters you can keep in mind before investing in blue-chip stocks:
1. Market capitalisation
It refers to the total valuation of a company’s outstanding shares. Multiplying a company’s total number of shares by the current market price gives the market cap value of that company. While looking for blue-chip stocks, find large-cap firms that are the bellwethers in their respective domain. For example, Reliance Industries, India’s largest company, has a market capitalization of Rs. 14,98,678 crore. Investing in shares of this company will always be a good idea.
2. Company earnings
Besides the market cap, take note of the company’s revenues. Companies with higher income typically have a more significant share in the industry. Compare the company’s quarterly and annual earnings report for a better insight into the company’s strengths and potential.
Before investing in the stocks of a company, it is recommended that you go through the balance sheet to understand if the company is financially sound or not. Read about how to assess a company’s balance sheet in our blog here !
3. Company valuation
While the market cap is an excellent metric to identify a blue-chip stock, it doesn’t reflect its intrinsic market value. Moreover, the market cap depends on the price you pay for the stock, subject to various economic factors. So, you should ideally opt for companies featuring among the top 5-10 in a specific sector or industry. The true worth of a company lies in its intrinsic market value. For instance, Tata Consultancy Services ranks among the top companies in the IT industry. Its share, in most cases, is traded above its intrinsic value.
4. Return on Assets (ROA)
ROA is a standard financial ratio that can help you identify companies efficiently using their assets to generate returns. The ratio considers the company’s debts as well. ROA gives an idea of a company’s profitability compared to its assets. Thus, a higher ROA indicates that a company is more efficient at generating profits from investments.
For instance, the ROA of Indian Bank as of March 2021 was 0.47. On the other hand, the ROA of HDFC Bank was 1.78 during the same period. Based on this metric, HDFC has better profitability, making its shares more attractive.
5. Return on Equity (ROE)
Looking at the ROE ratio can help you identify firms with profitability higher than shareholder equity. Thus, the higher the ROE ratio, the more efficient a company is at leveraging shareholder equity for profit generation. The normal ROE range differs with every industry/sector, a point you must remember before comparing the ROEs of peers.
6. Piotroski score (F-score)
The F-score is a distinct score between zero and nine reflecting a company’s financial strength. It considers nine discrete criteria of a company’s financial statements, such as net income, operating cash flow, return on assets, etc. The F-score is a helpful metric for identifying best value stocks, with zero being the worst and nine being the best.
The top blue-chip stocks to buy in India
Here’s a list of the top 10 Indian blue-chip stocks worth buying:
The takeaway
Blue-chip stocks have a higher potential for fetching high returns and are ideal for investors with a moderate risk appetite. Such stocks are popular among investors for whom the safety of their wealth matters more than short-term low returns. It’s pertinent to remember that even the best companies can collapse during turbulent times regardless of past stellar performance. So, you should diversify your investment portfolio to mitigate the risk of losing all your wealth during adversities.
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