Blue chip companies in India are considered most stables stocks for investing.
Blue chip stocks can give best long term returns. Why?
Because business fundamentals of blue chip companies are very strong.
How strong business fundamentals helps?
Such companies can make “profits” even in bad times (stability).
This is what makes blue chip companies so special.
But how “profit stability” translates into shareholders returns?
As their profits are more stable, blue chip company’s dividend payment history is excellent.
Dividend payment history? What does it mean?
Dividend payments to shareholders means, company is parting away with its profits.
Though it may sound as the logical-thing-to-do, but for companies it is a big decision. Why?
Because the temptation to retain all profits with the company is too high.
Why it is like this?
When profit is retained, the company has more cash.
This ensures better management of probably future liquidity crisis.
#1. Blue chip companies pay good dividends…
Dividend distribution is a problem for companies whose fundamentals (sales, profit, reserves etc) are not strong.
Hence a company which can distribute dividends even in bad times, becomes special.
Such special companies are tagged as “blue chip’s”.
“Consistent dividend payouts” are vital indicators for value investors. Why?
Because it shows how confident the company is about their future cash flows.
Future cash flow means:
- Assures cash-inflow (in form of net profit).
- Assured cash-outflow (all payments).
For a company to stay alive, these two (2) form of cash flows must continue to happen.
Though it may sound simple, but it requires best “business strategies” to ensure such a cash flow.
I will assume that less than 25% of all companies has this acumen.
We call these companies as Blue Chip’s.
What makes their cash flow so assured? Their competitive advantage.
What is competitive advantage? Lets take an example:
When an Indian wants to buy a car, the first name that comes to mind is “Maruti Suzuki”.
This kind of brand recognition contributes in building a competitive advantage.
Such companies has more “assured sales”.
#2. Build your list of blue chip stocks…
Personally, I would love to have a ready list of blue chip companies in India.
Having such a ready made list is like 50% job done.
For a novice investor, it is a great starting point to have such a list. Why?
Generally speaking, stocks investing is risky.
But buying stocks of only blue chip companies reduces this risk by 50%.
What is the advantage of investing in blue chip stocks?
They are more likely to give steady returns. Their price is also more stable.
#2.1 Undervalued blue chip stocks…
Buying stocks of blue chip companies reduces the risk by 50%.
What about the balance 50%?
The balance 50% risk can be reduced by buying these stocks at undervalued price levels.
Warren Buffett do not buy even blue chip stocks always. Why so?
Because in normal times, blue chip stocks trade at overvalued price levels.
It is very important to avoid overvalued stocks. How to do it?
By tracking price movements till it becomes undervalued.
Which stocks are undervalued?
Whose market prices is below intrinsic value.
Buying stocks of blue chip companies at undervalued price levels ensure good returns.
#3. Defining a Blue Chip Company…
Different people will define it differently.
I will provide my definition of it. It has worked wonderfully for me.
What is the necessity to define a blue chip company?
The short answer is, it will help you to pick your favourite stocks.
Longer answer is, defining formulates a theory based on which shortlisting good stocks become easy.
So lets see my rather long definition of blue chip companies…
This definition also works like a “stock screener” for me.
#3.1 Very Large Company
This is the first essential characteristic of a blue chip company.
One can use the following parameters to define the company’s size:
- Sales turnover,
- EBITDA or Net Profit (PAT),
- Net Worth.
Companies which has high sales turnover, high EBITDA/ PAT, and high Net Worth should be preferred.
Apply this screener on individual sectors.
Quick Tip: Pick the top 3 market leaders of all sectors.
#3.2 Established Company:
What means by an established company?
Established company is one which has very stable profits.
How to quantify stable profits?
Following parameters will help you to do it:
- Sales growth (last 10 years).
- EBITDA growth (last 10 years).
- PAT growth (last 10 years).
- EPS growth (last 10 years).
Not all company can display such growth metrics.
Only those companies which enjoys strong competitive advantage can display such metrics.
Can you name of company which enjoys a huge competitive advantage in its sector?
“Google” is the name.
It enjoys 81.7% market share as an OS provider for Mobile Devices.
How does this high market share helps Google and its investors?
As there is virtually no competition, Google use its Monopoly in setting pricing.
- Note: Gross Margin of Google is 60.72%
Such companies can increase their sales, and profits at a faster pace.
“Microsoft” enjoys the same kind of monopoly as an OS provider for computers.
- Note: Gross Margin of Microsoft is 55.97%.
Following example of few Indian stocks. Just for comparison sake:
- Infosys: Gross Margin is 37.06%
- TCS: Gross Margin is 89.93%
- Wipro: Gross Margin is 30.55%
#3.3 Strong Management:
This is the third essential characteristic of a blue chip company.
But how to define a strong management?
I prefer to keep it simple.
Look at the profitability of the company.
Which metrics one must see to judge profitability levels of the company?
- Return on Equity (ROE).
- Return on Capital Employed (RoCE).
- Operating Margin.
- Free Cash Flow yield.
It takes a lot of “smart” work on part of the management to maintain high profitability levels.
#3.4 Shareholders Value:
No matter how well the company is operating, it must also take care of its shareholders.
Shareholders has the only following two priorities:
- “Price appreciation” in long term.
- “Dividend income” in short term.
Though it may sound simple, but for a company it is a big challenge.
Very few companies can give both (price and dividend) to its shareholders.
Blue chip companies are more likely to ensure shareholders value than others.
#3.5 Price Valuation:
Would you like to buy a Kilogram of Onion at Rs.200 per Kg?
No, why? Because it is overvalued.
Normally onions are available at Rs.35-40/kg. We call it fair price.
Similarly, even shares like Apple, Microsoft, Google, TCS, Infosys must trade at fair price.
Even best of stocks are not worth buying when it trades at overvalued price levels.
How people can check is the price valuation is good or bad?
I use my stock analysis worksheet to do it.
People can use the following financial ratios to check price valuation of stocks:
- Intrinsic value.
- Free cash flow yield.
- P/B ratio.
- P/E ratio.
- PEG ratio.
#4. Blue Chip Companies & Dividend Distribution
Blue chip companies pay dividends more consistently.
Their dividend per share growth rates are also better.
Investors whose priority is income generation prefers to buy blue chip stocks.
Such investors do not buy stocks for capital appreciation. They want regular income.
Blue chip stocks are like tailor made for such investors.
Why people love dividends?
Dividend income is hard-cash earned by the shareholders.
Dividend is more comforting than hypothetical capital appreciation.
Consistent dividend generating characteristic of blue chip stocks makes it very special.
#4.1 Check EPS of companies
Companies which pay dividends are good for shareholders.
But a potential investor must not look only at the dividend history.
It is also necessary to check if company can pay dividends in future as well.
How to do it?
One must check the historic Earning Per Share (EPS).
What is EPS?
EPS = Net Profit / No of share outstanding.
What must people look into the EPS?
- If EPS remained positive for last 10 years.
- Has EPS grown fast in last 10 years.
- Dividend payout ratio (Dividend per share / EPS) of last 10 years.
There are companies who fake by distributing large dividends.
Shareholders receives dividends and they falsely assume that companies fundamentals are good.
But in reality this may not be true.
A company whose EPS is falling today, will pay less dividends tomorrow.
Similarly, a company which is paying a large proportion of its profits (EPS) as dividends, will pay less dividends tomorrow.
So income investors, who likes blue chip stocks, must check EPS regularly.
A continuously improving EPS is what is desirable.
#5. Prepare your own List…
We started this article with a theory that one must has their own list of blue chip stocks.
Now you have got an idea of how to shortlist good stocks.
Use these basics to build a list of your own blue chip stocks.
Start with preparing a list of sector leaders.
Keep note of the following metrics of these stocks:
- Size of company.
- Growth rates.
- Debt levels.
- Price valuation.
You can also take an example from the list of stocks provided below.
Prepare an excel sheet and keep tracking these metrics of your stocks.
Give yourself some time to get adapted.
In the beginning it may be overwhelming. So do not go ahead and start buying stocks.
My suggestion is to play with your list for the first 6 months.
Identify one stock from your list every 6 months.
This is that stock that has performed well in all parameters listed above.
Caution: Do not ignore the price valuation.
No matter how big is the company, if it is not trading at fair price, it is useless to buy it.
I use my stock analysis worksheet to check price valuation of my stocks.
List of Blue Chip Companies in India 2018
These are my list of blue chip stocks.
They may or may not represent a “copy-book” blue chip company.
But one thing is sure that they have potential to give high returns in future.
(Updated as on April’2018)
- Tata Consultancy Services Ltd.
- Bajaj Auto Ltd
- Larsen & Toubro Infotech Ltd.
- Infosys Ltd.
- Ajanta Pharma Ltd.
- ITC Ltd.
- Divi’s Laboratories Ltd.
- Vakrangee Ltd.
- Pidilite Industries Ltd.
- Hero Motocorp Ltd.
Check this link to get more details of above stocks. There are 25 blue chip stocks that has been identified.
[P.Note: When debt minus Cash is negative it means that, though the company is carrying debt, but it has enough cash to pay back all its debt.
Such companies are as good as debt free companies.]
Disclaimer: All blog posts of getmoneyrich.com are for information only. No blog posts should be considered as an investment advice or as a recommendation. The user must self-analyse all securities before investing in one.