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Investment Insights : Understanding Blue Chip Risk
I recently read an article (I would not disclose which one) that stated that investing in blue chips can still be a risky affair. The article suggested that investors should not simply look at such (blue chips) labels and conclude that investing in such shares of companies will be safe. Investors should instead focus on price and the long-term future of the company’s performance.
To substantiate his conclusion, the author used the container shipping company Neptune Orient Line (NOL) as an example. Though NOL was a component stock of the Straits Time Index, it was replaced in Sep 2012 by another company. He also illustrated how NOL’s financial performance has been dismal over the last few years and the company had even recently warned that it may be on SGX’s watchlist.
His arguments all sound reasonable except for one part; the author argued that just because a stock is labelled as blue chip it may not present lesser risks to investors. However, the author did not elaborate what he meant by “lesser risk” since the phrase denotes a comparison.
Making the comparison is important as it clarifies what the author is really trying to say. Investing is by itself a risky affair – that is just stating the obvious. Even investing in the Singapore government bond is not risk free. However, when investing in equities, blue chips present relatively less risk than small and mid-cap companies.
At a fundamental level, the range of return on equity (ROE) of the STI index as a whole between 2008 and 2013 is 7.5% to 19.4% compared to FTSE Mid-Cap index’s 1.1% to 24.4% and FTSE Small-Cap index’s -7.5% to 16.2%. Furthermore, though the FTSE Small-Cap index presents the largest ROE range of 23.7%, it provides the lowest median return for the period of 7.8% compared to 11.6% provided by the FTSE Mid-Cap Index and 13.7% by the STI index.
In terms of year-on-year EPS changes range, STI’s EPS change range between -55% and 119% while the FTSE Mid-Cap index ranges between -95.8% and 1106.8%. FTSE Small-Cap has the widest range of between -384.6% and 1409.7%. What this means is that the chances of experiencing a shock – pleasant and rude – from financial performance is more likely in small and mid-caps than in the blue chip STI itself.
The above illustrates the comparative risk of fundamental performance between the blue chip and non-blue chip companies but what about share price movement? Between the periods mentioned, weekly share price movement of the STI index range between -15.2% and 16.6% while the FTSE Mid-Caps range between -22.4% and 23.0%. Again the FTSE Small-Cap has the widest range of between -20.4% and 28.6%. While none of these figures provide any comfort to the faint hearted, the STI index shows less weekly volatility than the non-blue chips stocks.
So both the author and the market are right. Investing in blue chips is not a riskless affair but it presents less risk then investing in non-blue chip stocks. But that is just stating the obvious.
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