Blue-chip companies are those companies that are financially sound and hold a good reputation in the market of having consistent growth. The stocks of such companies are called blue-chip stocks and similarly, equity mutual funds that invest a major corpus in blue-chip stocks are known as blue-chip funds. Blue-chip companies are an alternate term for large-cap companies, as these companies have a large capital, are reliable, and are well-established. Blue-chip companies have a proven track record of sustaining market volatility and giving stable returns in both good and turbulent times.
Why the term ‘Blue-chip’ Company?
The term ‘blue-chip’ comes from the game of poker where the blue-chip among the blue, red, and white ones have the highest value. Today, the blue-chip stocks do not necessarily refer to the stocks that are trading at the highest price but those that guarantee quality and reliability. The companies that have a large capitalization with a strong balance sheet, lower/stable debt to equity ratio, or are debt-free earn good recognition in the market. This pulls up their equity trading in the stock market that makes their stocks highly liquid and the companies gradually become the market leaders in their respective industries. They get a good return on equity (RoE) and a good return on assets (RoA). RoA is an indicator of how effectively the company’s assets are used and returns on it without taking into account the debt. Debt is considered while calculating the share price along with the number of investors and profit. Blue-chip companies may have RoE equal to RoA or a lesser difference if it is debt-free/carries low debt.
Characteristics of Bluechip Companies
Blue-chip companies in India are largely the top 100 companies as per capitalization. They are listed down by SEBI and it is SEBI that lays down the categorization norms. Most bluechip companies have at least Rs. 20,000 crore of capital. The other features of bluechip companies are:
- They are good-quality stocks that have rising or stable stock prices and dividends. Dividends are the profit distributions to investors
- The blue-chip stocks are also vulnerable to market volatility but their solid financial position makes them resist the adverse conditions. Such stocks also struggle during times of extreme stress but are known to operate well. They have brand management to withstand the market downturns
- Because of recognition and reputation, they are frequently traded by both individual and institutional investors. This marks the high liquidity of blue-chip stocks and their easy trading on exchange markets
- Their trademark name and liquidity further make them less volatile and more reliable for new investors. Young investors who look for safer options among equities should invest in large capital or blue-chip stocks if they have an investment horizon of 5-7 years
- Blue-chip companies become the indicator of the market weather trends, whether it is bull or bear (rising or falling). They are the components of a country’s well-known market indices and averages. They may also showcase the industry trends and the business cycles it is going through
- They also signify the economic conditions of the nation as they share an institutional status in the economy
Should You Invest in Bluechip Stocks?
Every kind of investment depends on the investment goals, investment horizon, and risk tolerance of the investor. However, if you are an equity investor and wondering if you should put your money in blue-chip stocks, then yes. One, because they are the safest among equities, it is good if you wish to reap stable returns. Second, you can allocate a part of your invested money to blue-chip stocks in a diversified portfolio along with others so that it cushions the downsides of turbulence. When other mid-capitalization stocks or small-cap stocks may not deliver substantial returns, the large-cap stocks may perform or be steady. Apart from this, you also should consider the following factors:
- Blue-chips are large-cap companies that have almost reached their maximum growth, so they undergo slow growth. Even though they grow slowly, they are consistent and provide assured returns. So, if you are someone who wants guaranteed returns, then you can invest in bluechip stocks
- They are good for new investors or investors with low-risk profiles as they do not grow or fall rapidly. They stay steady, so if you want stable returns with low risk, invest in bluechip stocks
- As they grow gradually, blue-chip stocks can deliver better returns in the long term, so it is suited for investors with long-term investment timelines. You should invest for about 7-10 years
- Adding bluechip stocks to other investments will diversify your portfolio as well as lessen the negative impact of recession/economic stagnance. It will help in corpus building and can also help you to deal with inflation with your wealth creation over time
- Blue-chip companies also have a high price tag with them, so it may not be suitable for small investors
Benefits of Investment in Blue-chip Stocks
You may invest in bluechip stocks directly through Demat accounts or large-cap mutual funds. The fund manager will allocate a large section of corpus to such stocks, and you will have your share of profits. The reason that individuals or fund managers invest in bluechip stocks is its innumerable advantages as below:
By creditworthiness, we mean the ability of a company to repay its debtors. A credit-worthy company not only pays off debt on time but also distributes profits and dividends to its investors. They usually distribute the dividends quarterly and blue-chip companies establish themselves as a safe investment avenue for their investors. Although they have associated market risks, they are less risky than other equities.
The blue-chip stocks have a track of giving assured and stable returns to their investors. Their reputation makes more investors put in their money and a large capital inflow makes them afloat during bad times. Also, they help to accumulate wealth in the long term but grow steadily through the business cycle. As said earlier, it helps to diversify the investment profile of investors and reduces the burden of risks.
Owing to their creditworthiness and stability, blue-chip stocks are frequently purchased and sold in the market. It becomes easier for investors to sell off the equities when they need the cash. Similarly, the fund managers of bluechip funds can easily invest and withdraw from such stocks. One of the best benefits of blue-chip stocks is that they offer high liquidity.
- Long-term Financial Goal
While equities help in capital generation if you wish to create a corpus over years, invest in blue-chip stocks. They grow slowly but consistently, are secure investments, can survive during market headwinds, and lead to capital appreciation. You can achieve your long-term financial goals by accumulating wealth through blue-chip investments.
In India, the capital gains that you earn through blue-chip shares are treated as income under Section 80C of the Income Tax Act. The short-term capital gains (STCG) are taxed at the rate of 15% whereas the long-term capital gains (LTCG) are taxed at the rate of 10%. However, LTCG is subject to taxation only if the gains exceed Rs. 1 lakh. They are tax-exempt up to Rs. 1 Lakh.
Wrapping it up:
Blue-chip stocks are a synonym for large-cap stocks that have goodwill in the market and have a record of steady growth. Most large-capitalization companies have multiple revenue streams and hence, they can hold out against operational and economic setbacks. As they generate income from various channels, it spreads out the market risks and is, therefore, a safer investment option for stock investors. This is why they earn a brand name, are traded easily, and are highly liquid.