What does blue chip really mean? An accepted market definition is: "Larger companies with a long history of profitability and stability.
" The Australian Securities Exchange (ASX) revises this definition from time to time, and this version is different to the one that was posted on the web in 2008.
But what does this definition really mean? Let's take a look at the definition in detail.
"Larger companies...
" - Okay, so these companies are larger.
But larger than what? We can't look at the definitions for "large cap" versus "medium cap" or "small cap" because there is no standard definition.
This is a very subjective description.
If we prepared a list of all companies, and sorted it by market cap, where would we draw the line to distinguish large caps from medium caps? "...
long history...
" - These companies have a long history.
Well, how long is "long" - a few years? or ten years? or longer? "...
profitability...
" - So, how do we define profitability? Is this the profit after tax? Or perhaps profit before tax (EBIT)? What about the Return on Funds? ROE (return on equity)? or ROSF (return on shareholder funds)? Or what? "...
stability...
" - How on earth do we define stability? Does this really matter? We are told that it is good to have this type of company in our portfolios.
Lots of people talk about this type of company.
Lots of investors have these companies in their portfolios.
Our broker or financial advisor might recommend that we include these stocks in our investment portfolio.
So, how do we find out which stocks are (of this type)? Try this - Ask your broker or adviser for a list of blue chip stocks.
They probably won't provide one - because there isn't one.
If they do give you one, ask them what qualifies a company to appear on their list.
And if they do give you a list, it will be similar to a list from another source, but it will not be identical.
How did the term "blue chip" come about? Well, many years ago, the blue coloured chip in the casino was the most highly valued chip of all.
(by the way - These days it still is in some casinos, but not so in others.
) Blue chip stocks can be disappointing! Would it surprise you to hear that this type of company can be disappointing? Their share price performance is not guaranteed.
If you want to see capital improvement, there are times when you might be waiting quite awhile.
It only takes a common old bear market, or a severe market correction, to highlight how poorly many blue chip stocks perform over the medium term.
If you invest for the very long term, then that might be a different story.
But for short-term capital profits we want to see shares increase in value over several months, or at most a couple of years.
During the infamous Global Financial Crisis (GFC - aka Global Credit Crunch) of 2008, many blue chip stocks fell in value, and now in mid-2011 some 3 years later many of these blue chip stocks are still well below their market peaks of 2007-2008.
For anyone who is trying to simply ride out this period of poor market performance, they might be waiting a long time.
In the accompanying price charts there are many examples of Australian blue chip companies that fell in price during the GFC.
Many of them fell a long way - in the order of 50 to 70 percent.
And many of them are still below their highs.