Blue Chip Stocks Are NOT Sure Win

How did blue chip stocks get their name?

Have you ever wondered why blue chip stocks are called blue chip stocks?

It goes back to the classic three colour poker chipset. The chips are blue, white, and red, with blue chips having the highest value. Over time, a blue chip stock evolved to be synonymous with a high perceived value.

What is a blue chip stock?

While there is no fixed criteria to be recognised as a blue chip stock, generally speaking, the company is large, well known, well established, stable and financially sound.

Blue chip stocks are not low risk

Since blue chip stocks are often companies with proven successes and a track record of strong earnings, some investors may view them to be ‘low risk’ or even ‘sure win’.

Both assumptions are wrong.

Blue chip stocks are generally viewed as of lower risk as compared to other stocks from less established or small firms. However, it is not low risk when you compare it against other investment instruments such as government bonds. Blue chip stocks are also subject to volatility and failure just like any other stock.

Thinking that blue chip stocks are low risk can mislead the investor to not monitor the stock or be mentally prepared to lose his capital.

Take the fall of Kodak for instance. It was a giant in the photography industry for a century before it filed for bankruptcy in 2012.

In 1976, Kodak was so successful that they took 85% and 90% of the market share for camera and film respectively.

Kodak saw problems in 1984 when its customers switched to Fuji’s colour films as it was 20% cheaper. Throughout 1991 to 2011, Kodak released various digital products but sales kept falling.

Despite being a blue chip stock at that time, Kodak failed to reinvent itself with the industry disruptions. It was complacent and did not keep up with the digital revolution.

Even when Kodak came back on the New York stock exchange in 2013, reaching a high of over USD30, it is now around USD5.

The truth is that stocks are inherently risky as an asset class.

Heed recommendations from friends with caution

Many investors, even seasoned ones, are guilty of buying a stock simply because their friends introduced it to them. According to the friend, who also heard it from another friend, the stock may be at a ‘good bargain’ now. It may be a good time to ‘buy low sell high’. It may be a ‘sure win because it is a 52 week low’.

These chatter tend to fall short on analysis and insights on why the prices are as such.

They simply work on disbelief. As prices are unbelievably low now, it will magically rise.

The mechanics behind the rise is often unsubstantiated. There are no new business models or no proven groundbreaking launches. All these are merely market speculation

Large companies can underperform

The Small Firm Effect Theory predicts that smaller firms with lower market capitalisation tend to outperform larger companies.

Since smaller firms typically are more nimble, successful ones may be able to grow much faster than a large firm. As a result, research has shown that blue chip stocks can underperform as compared to their smaller counterparts in the long run. As such, there needs to be more factors of consideration beyond randomly buying a few blue chip stocks.

Similarly, if an investor is looking for capital gain, then instead of looking at relatively ‘stable’ blue chip stocks, growth companies may be more apt in achieving the investor’s goal instead.

Define your ‘win’

Before diving into any blue chip stocks, investors need to ask themselves what success looks like to them. Is buying the blue chip stock aligned with their financial goal?

If your reason behind buying a blue chip stock is any one of the below, then you need to do more research and due diligence:

A friend introduced it to me
Everyone is buying the dip
The brand sounds stable
It is low risk

Diversifying is a Must

Proverbs are wise for a reason. When you are told to not put all your eggs in one basket, it is to urge diversification. This applies for your investment portfolio as well.

Diversifying is all the more crucial in recent years with the many black swan events. We are raging amidst a pandemic, a strong political divide, and multiple disruptions due to the greater adoption of blockchain technology. Mergers and Acquisitions (M&As) are forming more larger and more strategic partnerships, and a cancel culture can bring down a company overnight.

With this as the backdrop, It is more important now than ever to diversify your portfolio.

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