Even Blue Chips get the blues, but as a rule they should beat inflation in the long term
By William Meyer
Blue chips are usually shares in large corporations that can boast steadily increasing profits and dividends, and, over time, have come to mean security and reliability.
Profits are subject to manipulation and so the trend in dividends becomes paramount. Dividend streams remain the most convincing “audit report” and verification of earnings. There is no argument about the value of a dividend payment.
To paraphrase Rockefeller: “The only thing that gives me pleasure is to see my dividends come rolling in” – and one does not have to be quite as mercenary as that to get the point.
The term blue chip is often bandied about loosely and just because your stockbroker refers to a stock as a blue chip does not necessarily mean it is one. You will need to do your own independent research to verify this.
A further point is that a true blue chip produces consistent real earnings growth, that is, positive growth after inflation. Many companies produce steady growth, but after the ravages of inflation there is no real growth, meaning the investor has simply taken unnecessary risk.
Blue chips can be regarded as total return investments due to the steady growth in price and dividends.
Examples of American blue chips are IBM and Kelloggs. In fact, IBM’s nickname is Big Blue. Until recently Kelloggs had not had a down quarter (lower profits) for 30 consecutive years. That is a fantastic record. In South Africa, firms such as Anglo American plc and Richemont are generally regarded as blue chips.
Investors should not expect to make a lot of money over a short period of time, but the long-term returns should comfortably beat inflation.
The sheer size of these companies gives you a measure of protection. They can withstand huge losses and write off entire divisions without any threat to their survival, but they are still vulnerable to normal business cycles, which enables investors to time purchases with a possible entry point perhaps once a year.
But bear in mind that a conglomerate with half its assets in good businesses and the other half in bad businesses won’t be more than an average investment. Often a strongly performing division can hide mistakes elsewhere, in which case the overall performance will be pedestrian.
You might consider adding blue chips to your portfolio to benefit from their reliability, stability and growing dividends. Again, it is important to consider the price/earnings ratio (p/e) and the dividend-paying history. (The p/e ratio tells you how many years it will take a company to produce the profits required to cover the amount of money you have invested). The p/e ratio will give you an idea of whether or not the share is expensive, but don’t be afraid to pay top dollar for the best.
If you buy an overpriced blue chip, with a very high p/e in relation to prospective growth, you will increase the risk and volatility of your portfolio instead of decreasing it. The p/e should be similar to or lower than that of comparable companies.
While you should watch your blue chips carefully, remember that even blue chips have setbacks and if you are a long-term investor it is not a good idea to ditch them.
Blue chips won’t protect you from market risk, that is, the risk that the stock market as a whole might suffer devaluation or re-ratings.There are no guarantees. The term blue chip comes from the gambling table, where the most highly valued chip was blue. Keep this in mind.
● If you are not happy with your portfolio performance or would like a second opinion, contact Fenestra for a confidential consultation.
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