Stay invested in blue chips !!!

A sharp upswing in the stock market in the past four trading sessions, following a two-month-long downward spiral must have confounded many retail investors The investors have suddenly realised the importance of consistency over flamboyance. These are times when investors can look at stocks, which are market leaders and have track record of consistent revenue and profit growth.

To see if there is something like ‘consistency’ in a topsy-turvy market, we constructed a ‘Blue-Chip Index’ comprising forty-five market leaders across sectors beginning January 1993.

This index constitutes companies like Reliance Industries, Tata Steel, HDFC, Hindustan Unilever and Colgate-Palmolive from FMCG, Ambuja Cements and ACC from cement sector, auto majors like Mahindra & Mahindra and Tata Motors, engineering giants like ABB, L&T and Siemens, besides leading stocks from pharma, financial services, hospitality and information technology industries. This has been done to ensure that all sectors in the economy are duly represented. The returns are seen over the course of last 15 years so as to cover all phases of economic cycle.

It was given that the blue-chip index will beat the Sensex, but no one could have imagined the extent of outperformance. If one had invested Rs 100 in Sensex at the beginning of January 1993, it would have grown to Rs 700 by February 2008. In the same period, an investment of Rs 100 in the blue-chip index would have grown to Rs 1,700 outclassing the Sensex by a staggering 141%.

In all these 15 years, seldom did it happen that the blue-chip index has underperformed the Sensex. The extent of outperformance also kept a secular upward trend and in the bull run, starting 2003, the outperformance grew leaps and bounds, indicating that blue chips are better placed to take advantage of emerging opportunities than their smaller rivals.

The returns are backed by an equally strong earnings growth by these blue-chip companies. Comparing the earnings growth and the value of blue-chip index, we found that if earnings in calendar year 2007 were 22 times that of 1993, the blue-chip index of December ’07 was only 19 times of its value in January ’93.

If one were to counter this argument, one easy criticism is that such blue-chip index will include stocks, which have actually become blue chips over the course of last 15 years. Infosys Technologies was not a blue chip in early ’90s, similarly Wipro, but number of such companies is insignificant in our blue-chip index. Rather, we have companies like HUL, Colgate, Tata Motors, ITC, M&M, Tata Steel, MRF, Raymond and Indian Hotels, which were top companies in their sectors even in early ’90s.

The paradox with stock market investing is that most often retail investors panic and sell-off in a falling market or they have short-term horizon. Only if they pay greater attention to blue chips rather than looking for goldmine in obscure ideas, they would beat best of the mutual fund managers.