The Financial Literacy Cell
The Black and White of Blue-Chip Stocks
Gone are the days when people used to be content with only one source of income. In a fast-paced world like ours, every single day is just as uncertain as the day after and it has been made quite clear by the current pandemic. Hence, everyone especially millennials and Gen-Z who are new to the working population want money pouring in from different directions to become the trending: self-sufficient. And to this day the stock market remains the most favorite place to derive profit from without having to devote abounding hours like a day job.
So, what can one do to have a steady source of income with minimal risk and effort? For the risk-averse portion of the portfolio, one has the options of highly rated bonds and treasury bills as they provide the utmost safety but the problem with them is that they have slender profitability and that too only in the short term as in the long term comes the aspect of interest rate risk.
Interest rate risk is the risk of reduced preference for fixed income security as a result of increased interest rates in the market.
For example, say an investor buys a five-year bond, Rs. 600 bond with a 3% coupon. Then, the interest rate rises to 4%. The investor will have trouble selling the bond and is also facing high opportunity costs. Now we revert to the good old stock market for steady and high returns, but one can’t help but get overwhelmed with the quantum of companies, investing strategies, regulations, financial jargon, and with an inability to achieve stability. And even after one musters up enough strength to go over all these things, there always remains the risk of exogenous factors like the ongoing situation.
However, just like the yang in the yin, there are various solutions for the problem at hand. The most prominent one is that of blue-chip stocks. Many might argue that the stock market is merely a gambling machine but the skilled believe otherwise. And they know one of the very few similarities between the two is over the term blue-chip. A person named Oliver Gingold of the Dow Jones Company addressed the stocks trading at very high prices as blue-chip because blue chips hold the highest value in the game of poker. However, the spectrum of blue-chip stocks gradually elevated from merely having extraordinary prices to astounding quality. Thus, blue-chip stocks are issued by corporations with very large market capitalization value and exceptional brand credibility. Generally, these companies are one of the top performers in their respective sectors if not the best performer. For example- Disney, Coco-cola, Apple, etc.
Let’s take the example of Apple and understand blue-chip companies.
Blue-chip companies have a very large market cap (Apple is placed 2nd in NASDAQ market cap rankings with that of $2063.49Blln. on Oct, 18), are components of Benchmark Indices (Apple is part of Dow Jones industrial average, NASDAQ 100, S&P 500), consistent dividend payouts (Apple’s dividend yield remains always above 1% and has only gone to the lowest of 0.6% in the current pandemic), strong cash flows (Apple’s free cash flow has been steadily growing from $2.275Blln. in 2005 to $58.896Blln. in 2019), high brand credibility, high revenues (Apple ranks 4th in Fortune 500 companies in 2020) and finally are sector champions (Apple is ranked 1 by fortune in Computers and Communication sector). Such companies have also generally reached their maximum potential thereby rendering slow but steady growth in its stock price.
The advantages of investing in the stocks of the blue-chip companies are also quite evident. The blue-chip stocks are subject to steady and regular dividends and slow and steady growth over a long investment horizon making it a haven for somewhat riskless investing and also substantially reduces the tax liability to only 10% upon Long term Capital Gains u/s 112A of Income Tax Act. Adding their ability to beat inflation in the mix makes them fairly at par with FD. Such stocks also experience exceptional liquidity and greater information transparency because of the company’s high goodwill, creditworthiness, and media coverage. The major advantage of these stocks over the stocks of newer companies and the market, in general, is its resistance against recessions, inflation and economic distresses. This fact is well illustrated through the example of IBM.
The retirement and estate planning as part of one’s financial plans also get benefitted by owning such stocks. Moreover, they help a person build a healthy corpus over a large span of time. Blue-chip companies are very smartly managed and are therefore actively pursued by passive funds. The ability of such companies to effortlessly raise capital from different sources also improves the existing shareholders’ condition. If properly placed in a portfolio of varied securities, they lead to effective diversification because their long-term consistent returns help to balance the loss of other securities and reduce the risk of the portfolio. Thus, if a person is risk-averse and is looking to make steady and safe long-term money, blue-chip stocks are the way to go. But the inherent problem of such stocks for an average player in the market is that these companies are generally maxed out on growth opportunities leading to low volatility and also lower returns in the short run. Couple this with exceptionally high stock prices (because of the features of blue-chip companies) such investment opportunities become very less likely for the common investor. To counter the problem of high prices a person has two options-
Dip in your cash flows to buy the shares in one go. Wealthy investors can go for this but investors like you and me can’t buy a substantial amount of such stocks by this method to have consistent returns and efficient diversification.
The more efficient solution, in this case, is investing in blue-chip mutual funds. A blue-chip mutual fund is categorised under equity mutual funds and primarily invest in blue-chip stocks. Here the investor doesn’t have to fully exhaust his cash position and at the same time can ensure effective diversification. For example, the SBI Blue Chip fund has shown an absolute return of 147.46% for a period of 10 years and only 6.69% for 3 years which further goes on to prove the benefit of long term investing in blue-chip stocks, Here is another example of Microsoft.
All in all, the stock market is a very mind puzzling place, to begin with, but can be understood if certain basics are kept in mind. If one’s financial planning is on point and if she knows her investment objectives, risk tolerance, and investing discipline then something as large as a global pandemic or world financial crisis cannot render her off-track. Blue-chip stocks bring out the essence of investing and detach people from trading nullifying various jargon and technicalities simply. Next time if you are going to invest money in the stock market make sure you keep aside the less risky portion of your portfolio to invest in blue-chips as winning in the marathon is always better than winning a sprint, especially in finance.
By Yashvardhan Bajpai