Big and Safe Blue Chip Stocks – Are They Really?

The term “Blue Chip” stocks was coined in 1920 by Oliver Gingold, an employee of Dow Jones. It was in reference to poker chips where blue chips held the highest value.

Many investors consider Blue Chip stocks to be the best of the best, and safest of the safest of investments. Superficially this might seem true, however are they really as safe as people believe them to be?

During a recession or economic uncertainty, Blue Chip stocks are often regarded as good buy and holds. It is because they are assumed to be so well established that they are able to weather any storm.

That logic holds true for many stocks, but there are also many “blue chip” stocks that have deteriorating business economics.

These are the stocks that look safe from the outside but are actually sheep hiding in wolfs clothing.

Stocks that once held their weight in the S&P 500 top 25 are hardly recognisable from10 years ago. Since 50 years ago all have but been replaced.

I surmise that in the next decade there will be yet again a reasonable change in the top 25 stocks. You will see some still remain, but alot replaced with stocks barely heard of.

The Australian stock market is roughly 1.9% of the global stock market. Compared to America which accounts for 42% of the global stock market capitalisation.

In the case of the ASX, many of the blue chip stocks have hardly changed in the top 25. That is because the Australian stock index is heavily composed of financials (banks) and miners.

I would argue that there is still some excellent quality businesses available to be found on the ASX. I just won’t be looking for them in the “blue chips”.

Disadvantages of Being Too Big

What happens when something grows too big? It either blows up like a balloon, becomes so large it consumes everything around them or stops growing.

Take a human as an example. As an infant we grow into a child, then a teenager, an adult and eventually an elderly. Now the growth as a teenager to an adult is often rapid, a growth spurt. As an adult we hardly change in height and our appearance roughly goes unchanged.

However as we get much older, our skin starts to sag, and in some cases shrink. You can take this analogy and translate it into business growth stages.

All companies start off young in their seed stage, and goes through the steps of growth; infant-teenager. Once a business has gained some traction in their growth they become established and self-sustaining; adulthood.

When a business is in adulthood they can either fall into complacency or continue to pursue larger sales and market share. Just like an adult getting a promotion and building their career path.

However, there comes a time when a person become elderly and unable to labour anymore. And if they have not built investments for retirement, they may have a tough time.

That is the downside of being a Blue Chip stock, eventually a majority of businesses will grow too big. When they grow too big, growth stops but will hopefully grow at the rate of inflation.

If however, like an elderly person that has no retirement plans they can see their business deteriorate. They not only grow to the point of no more growth, but they start to decline.

The size of a Blue Chip stock becomes their downfall when they cease to be relevant and unable to maintain any growth.

Blue Chip Price Vs. Value

Let’s take a look at a few examples of some Blue Chip stocks that have fallen from grace. I am sure at one point in time these stocks were exceptional businesses. But it goes to show that there is a difference between price and value, even when it comes to the “safest” investments.

AMP Limited (ASX:AMP) was considered the bluest of blue chip stocks, and had a share price of $13.30 in January 1999. That share price over the course of 24 years has been on a steady decline to $1.15 in 2023. Profits have been negative or barely existent in the last decade.

Retail Food Group Limited (ASX:RFG) has not recovered from the scandal that unfolded in 2017 due to unfair business practices to its franchisees. Shares outstanding have ballooned out of control diluting any initial shareholders and profits barely non existant.

The 4 big banks (ANZ, NAB, CBA and WBC) have had subpar earnings reports over the last decade. Even though, presumably during a time when Australia had the best property returns to date. How is it possible for banks not to capitalise on a growing property market?

NAB share price is the same as it has been 20 years ago, ANZ 10 years ago and Westpac 15 years ago. The exception has been CBA that is arguably the better out of the big 4, but not by much.

However it is not to say that blue chip stocks are bad investments. You always have to fall back to the question; “for this price that I am paying, what is it I am getting (value)?”.

Blue Chip Does Not Mean Quality

Big does not necessarily mean quality when investing in stocks. I would argue that they are many smaller companies within the ASX that offer a better proposition.

Statistically, more small companies will fail and go bankrupt than survive. Just as not small stocks will survive, not all big stocks will survive either.

In a global economy when competition is fierce and everybody is competing for market share, only those that stay relevant will thrive.

All large and established companies once started off small and unknown. However, only the quality companies will go on to be big but continue to grow.

The only downside to this is that those businesses that are able to achieve this will almost always trade at a premium to their value. But that does not mean you should not still but the stock.

Sometimes paying up for quality is a prudent investment decision than only buying undervalued stocks. There is a fine balance between paying for quality, which is why investing is an art not a science.

On the S&P 500 you have stocks like Alphabet, Amazon, Microsoft and Apple to name a few. These companies have market caps in the high billions and even a trillion dollars. They are so large but are still able to deliver growth rates in the high double digits.

On the ASX, there are many smaller business if you look hard enough that have far superior business economics than the largest businesses. They often trade at a discount, because most go undiscovered.

A stock price will be volatile daily and even monthly, but eventually price and value will meet. Time is a long-term investors best friend, eventually price will reflect a business’s underlying value which is the quality it provides.

Key Takeaways

• There is a misconception the big Blue Chip stocks are safe investments.
• Blue Chip stocks that provide quality long term value will provide outsized returns. However, those that fail to stay relevant will often meet deteriorating business economics.
• The size of a Blue Chip stock can be its disadvantage. Often the size of a business will lead to its downfall due to insufficient growth or unable to keep up with inflation growth.

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