Can Blue-chip Companies Continue to Grow Forever?

A couple of days ago, I was talking to a friend of mine about his investments.

After working with a tech company for two years, he wanted to start investing. Not sure where to begin, he was looking for some advice.

Someone suggested he only invest in blue-chip companies listed on the stock exchange.

The rationale behind this was...

• Blue-chip companies would always grow over the long-term irrespective of market cycles and therefore his investment will be safe in these companies.

He also wouldn't have to worry about reviewing his stock portfolio often.

This did not surprise me.

Most new investors have these odd expectations, which is usually far from reality and often misleading.

But before I get into why, let's find out what exactly is a blue chip company.

The term bluechip comes from the game of poker, where blue chips carry the highest value.

In the stock market, this holds true as well. Among all the companies on the exchanges, blue chip companies are the ones that are the most valuable.

They have a solid and reliable track record while also delivering long-term capital growth and consistent dividends. Moreover, they are not very volatile. This lowers the chances of a loss.

So, does this mean bluechips are a safe investment?

No, these characteristics do not guarantee safety.

They simply imply that blue-chip companies are safer than their smaller, volatile counterparts trading on the stock exchange (midcaps and smallcaps).

Moreover, none of these characteristics ensures that a blue-chip company will grow forever.

A fool's gold or real gold?

The top blue-chip companies change every few years.

Companies that traded at the top in year 2000 or 2005 or any other year are not trading at the top today.

In fact, several yesteryear blue-chip companies have wreaked havoc on the wealth of millions of investors.

They too were at one point in time, nationally recognised, well-established, and financially sound.

One blue chip company that comes to mind is Bharat Heavy Electricals Limited (BHEL).

Owned by the Government of India, BHEL is a power generation equipment manufacturer.

The company in 2009 had a monopoly in the power equipment sector. However, it later succumbed to competition from private players and the troubles of the power sector.

This led the stock price to decline. The company's share price fell almost 50% in the next two years causing investors to lose a truckload of their wealth.

What about Satyam Computers Services?

The company was also a blue-chip company that many investors lost money over.

An investigation had revealed that the founder, Ramalinga Raju, had fabricated revenues, margins, and cash balances to the tune of around Rs 70 bn.

The stock price fell and this sent shockwaves across the industry forcing regulators to implement stricter guidelines to protect investors.

These are just some of the blue-chip companies in India that didn't even last a decade. But if you were to cast a wider net, you will find several more across the country and the world that have met a similar fate.

Who would have imagined that Lehman Brothers, a 170 year old financial giant, would file for bankruptcy or that General Electric could be one of the worst-performing stocks in the market?

These blue-chip companies did go down, taking investors hard-earned savings with them.

Not an ideal world

But what if you were to get out before these blue-chip companies went down?

Isn't this the time to put active investing to good use?

Some investors will argue that they can foresee such issues/events and exit the stock after a handsome profit. But that is a fallacy, an unrealistic assumption, referred to as the hindsight bias.

What is a hindsight bias?

A hindsight bias is a psychological phenomenon that allows people to convince themselves after an event that they had accurately predicted it before it happened.

This can lead people to conclude that they can accurately predict other events.

Most investors (novice and experts) have in the past and will continue to miss such incidents. They would either remain clueless or ignorant. The sheer size of these companies with their impeccable track record can blind anyone to any uncertainty.

Think about it. Who could have visualised the fall of the Lehman brothers or Zee TV?

Nothing lasts forever

If we expect a blue-chip or any other company to grow forever, we are saying a company can outgrow an economy forever.

How is that possible?

Think about it from an economic perspective. Continuous high growth will always attract competition, resulting in lower profitability, loss of market share or worse, both.

Consider these blue-chip companies in the international markets (developed world) (Colgate, Unilever, Nestle etc).

	Current P/E (BSE India)	Current P/E (international markets)
Colgate	36.6x	26.3x
Unilever	62.3x	24.2x
Nestle	75.5x	45.8x
Maruti	79.8x	12.9x
Siemens	75.5x	22.3x

Data Source: BSE and Google Finance

Notice how they tend to trade at deeper discounts to their peers in the developing world. Now, this isn't unusual.

As economies develop, the growth rate of the companies in it starts to slow down, consequently affecting their valuation multiples.

So we can say with utmost certainty that blue-chips cannot grow forever at a pace higher than the economy.

In conclusion

What should investors do? Should they invest in blue-chips at all?

Although this past decade has been incredible for most of these blue-chips (Hindustan Unilever, Nestle, HDFC Bank, Asian Paints etc.), assuming they will continue to grow forever, delivering stellar returns is wrong.

But buying companies passively, holding onto them forever, hoping they will yield good results is also wrong.

A better approach is to spot good companies that carry the potential to grow over the long term. Base your decision on in-depth research and your risk-return appetite, not just the track record of a stock price.

Build a core portfolio with fundamentally strong, profitable companies that are market leaders and develop a balance between blue-chip companies and other companies.

If you only stick to blue-chip companies, chances are you will miss out on the next Tata Consultancy Services or Hindustan Unilever in the making.

Keep in mind that investing in stocks comes with a few inherent risks. Undertaking these measures won't eliminate risks, but it will surely minimise them.

Happy Investing!

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...