Many investors are drawn to owning blue chip stocks. This is completely understandable given their generally solid balance sheets, commanding market share position and maintainable earnings.
However, while these top tier firms have many attractive attributes and characteristics, it is often the lesser known, smaller second tier or perhaps even third tier firms that prove to be the more profitable investments.
Consider the performance of telecommunication giant Telstra (ASX: TLS) compared with four of its smaller telco rivals. As the chart shows, Telstra’s share price growth has been far less impressive than these rivals. While the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) has returned 6% over the past five years and Telstra has returned 20%, the share prices of rival firms are up between 266% and 2793%!
In the past five years Telstra has grown its revenues by around $100 million, from $25.4 billion to $25.5 billion, while its profits have declined from $4.1 billion to $3.9 billion. Likewise, earnings per share (EPS) have also declined, falling from 32.9 cents per share (cps) to 30.7 cps.
In comparison the four small rivals have smashed Telstra’s performance.
Amcom (ASX: AMM) reported revenue and NPAT (from its operating units) of $53 million and $7.9 million respectively in financial year (FY) 2009. For the financial year to June 2013, Amcom reported revenues of $158 million and NPAT of $20.8 million. On an EPS basis, this translated to an EPS increase from 4.4 cps to 8.5 cps over the period.
iiNet (ASX: IIN) reported revenue and underlying NPAT of $418 million and $25.6 million respectively in FY 2009. For the FY 2013 year, revenue and NPAT grew to $941 million and $60.9 million respectively. Meanwhile underlying EPS has grown from 16.9 cps to 37.8 cps.
M2 Telecommunications (ASX: MTU) reported revenues and NPAT of $203 million and $7.5 million in FY 2009. For the year just ended, M2 reported revenues of $681 million and underlying NPAT of $58.4 million. EPS has increased from 8.56 cps to 36.3 cps over the five-year period.
TPG Telecom (ASX: TPM) reported revenues and NPAT of $481 million and $17.7 million in FY 2009. For FY 2013, the company reported $724 million in revenues and an adjusted NPAT of $166 million. On an EPS basis, returns have risen from 2.5 cps to 20.9 cps — an outstanding increase!
Source: Google Finance
While a blue-chip portfolio has a reasonable chance of keeping up with the wider index, often it is smaller stocks that offer the greatest potential rewards. Investors prepared to experience a slightly higher level of risk also have the potential to experience higher rewards.
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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.