Not all bluechips are long-term wealth creators

An average long-term equity investor is often advised to invest in at least a few blue-chip stocks to give a boost to his non-equity investment portfolio. Every new equity investor who wants to invest in direct equities is advised by experts to invest in a blue-chip company as they are ostensibly considered most safe and a good long-term prospect for wealth generation. There are also many investors who consider these stocks as a good gift to give their minor heirs with the expectation that it will reap rewards by the time they become adults, i.e., in the long run. However, ask yourself this: do all the blue-chip stocks really offer a safe way to earn handsome long-term return that beats inflation by a good margin? Can you follow the fill it, shut it and forget it strategy with these stocks?What is a blue-chip stock? According to Investopedia, "a blue-chip stock typically has a market capitalization in the billions, is generally the market leader or among the top three companies in its sector, and is more often than not a household name."As per new guidelines issued by the Securities and Exchanges Board of India (SEBI), the top 100 companies by market capitalisation listed on the exchanges are considered as large-caps. However, this list is too big for the average equity investor to pick the right stock for the purpose of long-term investment. Hence, for ease of shortlisting, an investor often goes to a shorter list of blue-chip indices like the Sensex with 30 companies or the NIFTY 50 with 50 companies.Should you fill it, shut it and forget it?Going by the past track record, the odds will most probably be against you as on majority of occasions, you will be wrong especially for a period over 10 years. When tracked over a long period, a large number of companies, which are part of blue-chip index, do not survive in the list for long. Sample this: out of 30 companies which were part of the Sensex in 1996, within a period of 25 years, 21 companies are now out of the index. A majority of these are not even in the top 100 list now. Similarly, 17 companies that were part of the Sensex in 2001, are now out of it. The story is not different even in much shorter span of 10 years as 12 companies from the Sensex 2010 list are no longer part of it."No one can tell with certainty which stock will do well for over one or two decades, especially in current times when disruptive new-gen technology is affecting all sectors," says Vikas Singhania, CEO, TradeSmart, a discount borkerage firm. No room for complacency There is no denying the fact that most of the blue-chip companies have the backing of excellent performance due to which they have reached the top. However, when it comes to maintaining the top position, a good number of these companies often fall short. "The companies that were blue chips 10 years ago may not be blue chips today and similarly blue chips of today may not be blue chips tomorrow," says Rishad Manekia, Founder and MD, Kairos Capital, a Mumbai based financial advisory firm. Only 4 companies from the top 10 list of Sensex 2001 have survived in the top position in 2021. Listing in blue-chip index helps but not a guarantee for future"The indices, mainly the benchmark indices, are constructed in such a way that it includes those companies that are doing well and remove those that are not doing well or have some internal governance issues. Only the leaders of the industry in terms of market cap, volume and lower volatility are included in the Indices. This way, the index reflects the best in class in the economy among the listed players. Thus, if a company is in the main index, there is at least a first round of due diligence that has already gone in and one can safely invest in them," says Singhania.Investing in a company which is part of a blue-chip index also has other advantages, however, that is no guarantee for consistent performance over the long term. "The investment from passively managed funds does increase the demand for these index companies but at the same time, other market participants may not necessarily have the same view of investing in some of these companies. So, by just being a part of the index does not mean that company will enjoy more returns by default," says Harshad Chetanwala Co-founder- MyWealthGrowth.com, a Mumbai-based financial planning firm.Here are a few big name companies which were part of the benchmark indices not too long ago, and due to various reasons some of these could not match the growth of other top companies while many others saw enormous erosion in wealth, got knocked out of the top 100 list: Tata Power, Bharat Heavy Electricals, Lupin, Reliance Communications, Reliance Infra, Yes Bank and Zee Telefilm. "Market capitalisation is an important factor in stock market investing, but certainly not the only parameter. Direct stock investment is different from investing in Index funds offered by mutual funds. Stock investing is more concentrated as you invest in a handful of companies. For this reason, you have to study and do some research on the companies before directly investing in their stock," says Chetanwala.The right strategy for monitoring a blue-chip stockIt is definitely a risky approach to buy one blue-chip stock and forget it for years and expect it to deliver a fortune. "While it is necessary to keep a track of every investment one has, even if it is a blue-chip stock, it is extremely important to track them every quarter. Listening to management commentary at least once in a quarter and going through their financial numbers is important to understand what is changing. Take the case of Yes Bank, one could have sensed the bank was in trouble even before its numbers were reflected in the quarterly results," says Singhania.All said and done, one should not also get too anxious and start monitoring their blue-chip stock too often. "Well-established companies with a long history may not need to be watched like a hawk, but the younger ones need special attention," adds Singhania. So are there companies that have been a part of the benchmark indices since they were first included? Yes, here are a few of them: Hindustan Unilever, Nestle, Reliance, ITC, SBI, Bajaj Auto, Manindra and Mahindra and L&T. These companies have been part of Sensex for more than two decades by virtue of sheer consistent performance."There are many bluechip stocks where you can buy and hold them without getting into the hassles of reviewing. The key is to invest in the right companies at the right valuations. One can look at reviewing the companies once or twice a year or whenever the stock market cycle changes," says Chetanwala.You must take extra cautions at the time of investment to thoroughly evaluate the qualitative aspects. "One has to check out the valuations and the overall growth potential of the company as well. Along with this, more understanding of the company's management and the potential of the sector can help in making more informed decisions," says Chetanwala.When should one exit a blue-chip stock?In equity investment, timing your exit is key. "Not all bluechips remain the best investment option over the long term. One should keep a close eye on the RoCE of a company. Any number below 15% (which is the cost of equity) means a company is not able to generate return on capital above the cost of equity. Some companies lose their bluechip status as economy transforms and sector dynamics changes," says Manish P. Hingar, Founder, Fintoo, an online financial planning firm.When a company fails to deliver consistently it may be the right time to move out and move to a better performing stock. "There are possibilities where the company may continue to make wrong business decisions or their management have their vested interest, in such a case you should relook at them and if required exit such companies," says Chetanwala. There could be situation where the the capitalisation of the company may change completely. "If there is a substantial reduction in the market capitalization of a bluechip stock and it becomes a medium capitalization stock, then it will be prudent to exit it and switch to a better performing stock," says Hingar. However, exiting a stock because of a challenging time may not always be the right strategy as many good companies do make a strong comeback. "Companies may go through difficult patches during unfavourable market cycles and hence a strong conviction on the business is a must at the time of investing in these companies. If the company's prospects look good then you can hold on with such companies. Many bluechip companies that were fundamentally strong went through difficult times during the pandemic, but they bounced back in a much stronger manner when things started getting better. You can continue to remain invested in fundamentally strong businesses and companies," says Chetanwala.For instance, Wipro and Adani Ports & SEZ were out of Sensex for some time, however, are now back in the reckoning to be back in the barometer index. Many new industries with higher growth potential often replace even a good performing large cap stock, which is why its exit from the top index may not translate into poor performance. Some of the companies with established businesses like Dr Reddy's Laboratories, Cipla, Gail India and Hero MotoCorp are out from top 50 list but still in the top 100 stocks' list. Is ETF or index fund a better alternative?Index ETF or index mutual funds are a good way to take advantage of the average return of the desired market capitalisation category. On many occasions index ETF/funds have beaten actively managed funds when it comes to return. As the index always replaces the nonperforming stock with a performing stock so investing may not require you to monitor your investment."Over the long run, it is difficult to beat the index, as was demonstrated by Warren Buffett in his well-documented wager with Ted Seides. The high cost of an actively managed fund rarely beats the lost cost of passive funds. Most of the stocks that are in the indices are already present in an actively managed fund, though their weights may differ. But a fund manager may prefer to buy some stocks to gain alpha, which may or may not be productive. In the end, it is the cost that eats away any benefit that alpha generates in most cases," says Singhania.So, if you are not comfortable with the risk associated with an individual stock selection or do not have the expertise or time to review your stocks periodically, should you consider investing in these funds?"Index funds overcome the bias of human discretion. As it is a passive fund, it just tries to track the index. Instead of buying selected stocks from the index which can become risky due to high portfolio concentration, an index fund will buy all the companies in index in the same proportion which reduces the risk of concentrated bets," says Hingar.Chetanwala says "Index ETFs or Nifty 50 or Sensex Index based passive funds are much better investment options for investors who would like to take a less or limited risk. This is a better way of investing when compared with investing directly in selected bluechip companies. The investment in the Index Fund is diversified and this help in reducing the risk as well."When it comes to choosing between an index ETF and index MF, it is the ETF that has an edge of index mutual fund. "Between an Index ETF and an Index Mutual Fund, the main difference is the cost. Generally, the ETFs have a lesser cost over Index Mutual Fund and would thus be the preferred vehicle for investment," says Singhania.

from Economic Times https://ift.tt/3A2xOBu