THE term “blue chip” in the world of investments refers to any investment that is considered to offer good returns at minimal risk. With reference to the stock market, blue chip counters are the stocks of large companies with established tra
ck records of consistently good performance, which translates to consistent share price performance.
In the Zimbabwean context, counters considered to be blue chip include Old Mutual, Delta, Meikles and Afdis to name a few, with other counters such as Innscor having picked up the tag of late.
It is perhaps ironic that the term was borrowed from gambling terminology, where the ‘blue chip’ is the highest value token that one can get, and thus implies taking the biggest gamble.
Blue chip counters have traditionally been considered the counters to buy and the Zimbabwean situation is no different.
This was especially so over the course of last year when the turbulence in the financial sector resulted in investors adopting defensive investment strategies.
The share prices for the largest capitalised companies (a grouping which is made up mostly of the blue chip counters) on the stock exchange went up just over 300%, compared to around 30% for middle capitalised companies, and a decline of almost 50% for the small capitalised companies.
Their prominence is also underscored by the fact that most of the industrial index’s movement is attributable to these counters; when Old Mutual and Delta sneeze, the market does indeed catch a cold.
In view of these characteristics, it does therefore seem to make sense that investors should buy into these counters. And that is what happens in practice.
Because they are liked by everyone, however, the shares tend to then trade at a premium to their true value (intrinsic value). You thus find the shares trading at a price that may be anything up to over twice their true value. This in itself does not present a problem, as long as everyone remains of the opinion that they are worth paying the premium — and this situation may continue indefinitely.
Because of the hype attached to such shares, they tend to be well-analysed, and also tend to trade more actively than non-blue chip counters.
Because analysts tend to look at such counters very closely, their results generally come out in line with market expectations; significant earnings surprises are seldom witnessed in this market segment.
They seldom become undervalued and they also tend to have steady share price movements, unlike their less popular counterparts. For these reasons, returns on blue chip counters tend to be in line with the average return of the market as a whole.
For the conservative investor, therefore, blue chip counters are an attractive investment option, as they promise stability, market-related returns (which would generally exceed returns on the money market, for instance) and are easy to acquire and liquidate, as they trade readily on a daily basis.
Such an investor can buy these shares and hold onto them without having to worry much about monitoring the share’s performance on a day-to-day basis.
The common idiom “low risk, low return” does come into play, though, and it is for this reason that the investor seeking abnormal returns would find blue chip counters unattractive.
The absence of earnings surprises means that share price volatility is reduced, and it is share price volatility that is the source of abnormal gains (and losses!).
The non-blue chip counters, because they are less popular, are generally avoided and thus tend to get undervalued, especially in a flat or bearish market.
Their lack of popularity also means analysts are less likely to look at these, and it is only when they publish information pointing to a higher valuation than their current price (mainly results, which may be significantly better than their blue chip counterparts) that they get noticed, and their prices are revalued upwards suddenly.
This is the source of abnormal gains. When such performances are repeated over time, the non-blue chip counter will eventually also attain the blue chip status.
On the other hand, because of their smaller sizes, market shares, balance sheets, and lack of experience/expertise (implied by their not having a solid track record), non-blue chip counters have a harder time making it through adverse economic conditions, and thus tend to succumb to these time and again.
The risk of loss is thus greater for an investor exposed to such companies’ shares. It would thus seem to make sense to be ‘safe than sorry’, and avoid this segment altogether, and this would be a valid observation, were it not for modern portfolio theory.
While the risk one is exposed to when one buys one risky counter may be high, it is significantly reduced when one extends this to two counters. The decrease becomes even more marked with three, four and more counters.
Expected return on the other hand does not reduce in the same proportion with the addition of more counters, and thus it is possible to get a portfolio of non-blue chip counters with expected returns higher than a blue chip portfolio, but with low overall risk, possibly even lower than the blue chip portfolio (ie have your cake and eat it!).
Various portfolio-structuring tools are available to assess the impact that bringing together different combinations of individually risky counters has on the overall risk and return of a portfolio. (Our site http://www.adway.co.zw gives some of these).