The Motley Fool

What is a Blue Chip Share?

 

Blue chip sharemarket chart

Image Source: Getty Images

Article Last Updated: 30 April 2020

A blue-chip share is a share that’s considered the best of the best, like a casino’s most expensive (blue) chips. Its name commands financial stability, long-term growth, a strong track record, and even prestige – all the positive characteristics that come with being one of the market’s top companies, and having held that position for some time. 

Although there are no hard and fast rules about what makes a blue-chip blue, here are some of the characteristics of blue-chips, how they perform, and how you can invest in them.

What are blue-chip shares?

Blue-chip shares are the market’s biggest and brightest equities – the companies investors hold in the highest regard. Blue-chips have usually demonstrated the following traits over many years:

  • Financial strength — low or modest debt, a strong credit rating, and plenty of cash
  • Attractive business model and economics — defensible position, and generates good cash flows
  • Respected management team — long-tenured executives with strong track records
  • Growth over the long term — shown strong growth and future growth is promising
  • Strongly performing share — share price has risen over the long term
  • Large market capitalisation — among the largest in its industry, if not the largest

These are some of the major characteristics of blue chips, and while most blue-chip shares should have all of these traits, they might be missing 1 or 2 at any given moment. During a recession, even the best shares can struggle to grow profits. But over the long term, blue chips have an excellent record of generating returns for investors.

A blue-chip share is generally a constituent of a prominent share market index like the Dow Jones Industrial Average in the US. Although there is no official list of blue-chips, the best place to start here in Australia would be the S&P/ASX 20 Index (ASX: XTL).

Which shares are in the S&P/ASX 20 Index?

The S&P/ASX 20 Index is an Australian share market index, created and maintained by financial services giant Standard and Poor’s (S&P). It’s the narrowest ASX index on offer by S&P and as of March 2020, accounted for 45% of the Australian equity market. The ASX 20 Index is designed to track the value of the 20 largest companies on the ASX, ranked and weighted by market capitalisation.

Market capitalisation refers to the total value of a company’s shares within the share market. To calculate this, just multiply the company’s share price by the number of shares on issue. For example, if Company A had issued 1 million shares and these shares were trading on the ASX for $5, its market capitalisation would be $5 million.

To construct the ASX 20 Index, all companies on the ASX are ranked by market capitalisation, with exchange-traded funds (ETFs) and listed investment companies (LICs) excluded. The largest 20 shares that meet the minimum volume and investment benchmarks are then eligible for inclusion in the index. This process is repeated quarterly in order to rebalance the index, adjusting for the inevitable changes in market capitalisation and liquidity.

When an index is weighted according to market capitalisation, as is the case with the ASX 20, a company’s representation within the index is based on its size. In other words, the companies with the largest market capitalisation make up the largest part of the index. The larger the weight, the greater influence over the index’s day-to-day movements.

As of 1 April 2020, here’s the lay of the land for the S&P/ASX 20 Index:

Name

Sector

Weight

CSL Limited (ASX: CSL)

Health Care

16.39%

Commonwealth Bank of Australia (ASX: CBA)

Financials

13.32%

BHP Group Ltd (ASX: BHP)

Materials

10.39%

Westpac Banking Corp (ASX: WBC)

Financials

7.25%

National Australia Bank Ltd (ASX: NAB)

Financials

6.06%

Australia and New Zealand Banking Group (ASX: ANZ)

Financials

5.85%

Woolworths Group Ltd (ASX: WOW)

Consumer Staples

5.39%

Wesfarmers Ltd (ASX: WES)

Consumer Discretionary

4.73%

Telstra Corporation Ltd (ASX: TLS)

Communication Services

4.44%

Transurban Group (ASX: TCL)

Industrials

4.01%

Rio Tinto Limited (ASX: RIO)

Materials

3.82%

Macquarie Group Ltd (ASX: MQG)

Financials

3.70%

Goodman Group (ASX: GMG)

Real Estate

2.69%

Newcrest Mining Limited (ASX: NCM)

Materials

2.16%

Woodside Petroleum Limited (ASX: WPL)

Energy

2.11%

Brambles Limited (ASX: BXB)

Industrials

1.97%

Insurance Australia Group Ltd (ASX: IAG)

Financials

1.74%

Amcor PLC (ASX: AMC)

Materials

1.61%

Suncorp Group Ltd (ASX: SUN)

Financials

1.40%

Scentre Group (ASX: SCG)

Real Estate

0.99%

Now the S&P/ASX 200 Index (ASX: XJO) – the primary benchmark index when talking about Australian shares – is infamous for being skewed towards financials and, to a lesser extent, materials. Just one look at the sector weighting of the ASX 20 Index and you’ll see why. Since the ASX 200 is market-cap-weighted, the shares in the ASX 20 are given the greatest weighting – a combined 55% as of April 2020. So when the breakdown of the ASX 20 is as follows, it’s no wonder the Australian equity market is dominated by financials.

S&P_ASX 20 Index Sector Weights

Data source: Market Index. Chart by author.

As we prefaced earlier, however, there are no hard and fast rules when it comes to blue-chips. The S&P/ASX 50 Index (ASX: XFL) may contain many more blue-chip shares, as may the ASX 200, depending on how strictly you apply the criteria. If you read widely, chances are you’ll find that the term ‘blue chip’ is used quite loosely. But since you’re reading this report, you’ll be armed with the knowledge to make an informed decision for yourself. If in doubt, just revisit the dot-pointed characteristics we walked through earlier.

How do blue-chip shares perform?

As you’ll see below, the movements of the ASX 20 Index closely resemble that of the ASX 200 Index. This is to be expected because, again, the ASX 200 is weighted by market capitalisation, and so the largest shares have the greatest influence.

S&P_ASX 20 and S&P_ASX 200 Performance

Data source: Market Index. Graph by author.

The graph below illustrates the annual returns of the ASX 20 Index between 1993 and 2019 – compared to the returns of the ASX 200 Index for reference. As you’ll see, blue-chips aren’t immune to the market downturns that are part and parcel of investing in shares. However, history shows us that in the long run, the market has always gone up. Between 1993 and 2019, the ASX 20 Index delivered an annual average return of 6.62%, while the ASX 200 Index slightly outperformed with an average return of 6.77%.

ASX Annual Returns_ 1993-2019

Data source: Market Index. Graph by author.

From operations to financing to strategy, size confers some huge advantages, and well-run blue chips use their size to improve their market position. 

Blue chips tend to outperform smaller companies for several reasons:

  • Their large size gives them operational efficiency — businesses that operate at scale enjoy the advantages of being efficient, including profits from synergies that smaller companies can’t realise.
  • Their large size gives them a financing edge — whether it’s via cheaper debt or easier equity, large companies command respect, and investors are more willing to lend them money due to their stability.
  • Their large size gives them strategic advantages — unlike lesser-financed rivals, blue chips can actually acquire their competitors, especially during an economic downturn or recession when smaller companies struggle. Or perhaps they can divert potential customers away from a rival by leveraging industry power and connections. Size offers significant strategic opportunities to large, blue-chip companies.

Top ASX blue-chip shares for investors

Here’s a rundown of 3 of the most popular ASX blue-chip shares and where they stand today.

CSL Limited 

CSL, the undisputed darling of Australian healthcare, holds the coveted title of Australia’s largest public company, boasting a market capitalisation of $145 billion. It began life in 1916 as the Commonwealth Serum Laboratories, a government enterprise established to safeguard the health of Australians fighting in World War I. From there, CSL produced a vaccine for the 1919 Spanish Flu and over the ensuing years, provided Australians with access to 20th-century medical advances such as insulin and penicillin. Today, CSL competes on the world stage to deliver a range of life-saving and life-extending products to treat various medical conditions.

After listing on the ASX in 1994 at a split-adjusted price of just 76.6 cents, CSL shares have experienced astronomical growth to sit at $320 at the time of writing – an incomprehensible 41,675% gain. For context, a $10,000 investment in CSL shares in 1994 would be worth a cool $4.2 million today. Not a bad return on investment, right?

CSL’s 10-year price chart (below) speaks for itself.

CSL 10-year price chart

Chart source: Fool.com.au

This is a phenomenal growth story that has been built on the back of industry-leading efficiency, astute acquisitions, a relentless research and development pipeline (R&D), and sound capital management.

CSL’s products are split into 2 main divisions: CSL Behring, which manufactures plasma therapies, and Seqirus, the second-largest flu vaccine maker in the world. Within CSL Behring is the company’s Plasma division which operates one of the world’s largest and most efficient plasma collection networks. Here, CSL collects blood, predominantly from centres in the US, and then separates it into several components, such as antibodies, albumin and proteins, for a range of therapeutic uses.

With a highly valuable R&D pipeline, tremendous scale and efficiency, leading market share, pricing power and robust margins, CSL’s place at the top of the ASX is certainly well-deserved. As a result, CSL shares seemingly always trade at a premium on the market, which is reflected in its current price-to-earnings ratio of 46. This compares to the ASX 200 average of around 15. But considering CSL’s remarkable track record to date and potential future upside, perhaps that’s the premium afforded to greatness.

If you’re interested in some more light reading on CSL, you can learn about what drives its growth here and why it may be a top buy in 2020 here.

Commonwealth Bank of Australia

As the largest bank in Australia by a comfortable margin, Commonwealth Bank needs little introduction for most investors. CBA has long been a staple of many ‘mum and dad’ share portfolios and is arguably the most popular ASX share with retail investors. Just enter the search term “CBA share price” into Google Trends, an online tool that analyses the popularity of search queries on Google. Chances are, you’ll find that CBA attracts more interest on Google than any other share you compare it to.

This is likely due, in part, to the familiarity of CBA’s business. Many investors, at least at the beginning of their investing journey, often stick to companies that are present in their everyday lives. And as Australia’s largest bank, CBA is ever-present in our society. What’s more, CBA shares offer something retirees in particular love – a (historically) juicy fully franked dividend yield which currently sits at 7.35%. As a result, CBA had been sitting pretty at the top of the ASX for quite some time until it was eclipsed by CSL in the March 2020 bear market.

Similar to CSL, Commonwealth Bank began its life as a government enterprise in the early 1900s. After starting out as a savings and trading bank, CommBank progressively acquired the responsibilities of a central bank. Its dual role came to a head in 1960 with the creation of the Reserve Bank of Australia to take control of the nation’s central banking operations, and Commonwealth Banking Corporation to provide traditional banking services. The Commonwealth Banking Corporation went on to privatise in 1991, listing on the ASX and becoming what we now know as the Commonwealth Bank of Australia.

Today, CBA employs over 50,000 people and offers a full range of financial services to around 17 million customers. Its primary activities include personal, business and institutional banking, home loans, insurance, and investing services.

CBA dominates the markets it operates in and has consistently boasted a higher return on equity metric than its rivals (12.7% in 1H20). However, the ASX banking sector faces some major headwinds in 2020. The economic fallout from the coronavirus, the extent to which is still unknown, will certainly extend to the banks. A hibernating economy with rising unemployment numbers will likely lead to a spike in bad debts and a deteriorating property market. Meanwhile, record-low interest rates put pressure on profitability. So although CBA was the only big 4 bank not to cut its dividend or franking level in FY19, the chances of this repeating in 2020 are very slim. Just some food for thought!

Wesfarmers Ltd

Wesfarmers is an Australian conglomerate behind many well-known retail businesses, such as Bunnings, Officeworks, Kmart, Target, and online retailer Catch. It also has an industrial division with operations in chemicals, energy, and fertilisers; as well as investment stakes in ASX 200 companies BWP Trust (ASX: BWP) and Coles Group Ltd (ASX: COL). In regard to the latter, Wesfarmers sold a significant portion of its Coles Group shares in February and March 2020, capitalising on the up-trending Coles share price in the wake of coronavirus-induced panic buying. This leaves Wesfarmers with a 4.9% stake in Coles, however, it still owns 50% of the Flybuys business.

The major drivers of Wesfarmers’ revenue are as follows:

Wesfarmers Revenue by Segment ($m)

Data source: Company Presentation. Chart by author

Wesfarmers has been around since 1914 and became a publicly listed company in 1984. Being a conglomerate, Wesfarmers is diversified in nature as its operations are spread across a number of businesses and industries. What’s more, Wesfarmers is well and truly cashed up after its sale of Coles shares, putting it in a strong position to weather the coronavirus storm and continue to diversify its earnings through acquisitions.

This all culminates in a company that has an impressive long-term track record, a large degree of financial flexibility, strong brand power afforded to its businesses, significant scale and a large chunk of market share in the industries in which it operates. With this comes an attractive dividend yield – 4.06% on current prices, which grosses up to 5.80% with full franking. It’s no wonder Wesfarmers has long been a favourite of Aussie investors – which again also likely traces back to the strong presence of its brands in everyday life.

How do you buy blue-chip shares?

If you’re looking to buy the blue chips, you have several options. Here are 2 easy ways to buy the top companies in Australia:

  1. Buy individual blue-chip shares
  2. Buy the index via an ETF

First, you can buy any individual share in the ASX 20 just as you would any other share. Place the buy order with your broker, or as is more commonly done nowadays, use your online brokerage to make the trade, and you’re all set. 

Exercise the same care in investing in blue-chips that you would for any individual share. You’ll need to use your investment process to analyse the company and assess its future potential. While they may be a better breed of company, blue-chips are still subject to the same factors that can rattle the whole market. That means they can decline, sometimes precipitously, if bad news hits the headlines. Even the best blue-chips do poorly from time to time, especially during recessions. So, that’s one reason you need a diversified portfolio of companies, not just one blue-chip investment. 

And that’s where the second option for owning blue chips-comes in, especially for newer investors who aren’t comfortable analysing individual shares, or for investors who are pressed for time. You can simply own the entire lot of the largest blue chips by buying an ETF based on the ASX 20. This means you’d own the top section of the market – which we know has returned around 6% annually since 1993. It’s cheaper than trying to buy each of the shares separately (since you’ll incur brokerage costs per trade), and it’s much more convenient, too. 

With that being said, if you do decide to go down this path, you won’t be presented with many options. At the time of writing, there’s only 1 ETF of this variety: iShares S&P/ASX 20 ETF (ASX: ILC). This ETF is designed to track the ‘accumulation’ version of the ASX 20 Index (before fees), which assumes that dividends are reinvested back into the index.

If you were to broaden your horizons, however, and consider a less narrow index, the range of ETFs to choose from suddenly expands. State Street Global Advisors offers the SPDR S&P/ASX 50 Fund (ASX: SFY) and there are a handful of ETFs on the market designed to track the ASX 200, such as the BetaShares Australia 200 ETF (ASX: A200). You also have the Vanguard MSCI Australian Large Companies Index ETF (ASX: VLC), an ETF that currently comprises 29 holdings and is designed to track the performance of approximately 70% of the investable Australian equity universe.

If you’re interested in going down the path of investing in ETFs, take a look at our Top ETFs for 2020 page. Don’t let the name fool you – before diving into the ETF picks, it comprehensively walks through the ins and outs of investing in ETFs, including what they are, the pros and cons, and the different types.

As a bonus 3rd option to invest in blue-chips, there’s also WAM Leaders Ltd (ASX: WLE), an LIC provided by Sydney-based investment manager Wilson Asset Management. Put simply, an LIC is an investment company that manages money for its shareholders, investing in companies according to a strategy of its choosing. You can invest in an LIC on the ASX just as you would a share or an ETF. 

This particular LIC, WAM Leaders, “provides investors with diversified exposure to a portfolio of undervalued growth companies within the S&P/ASX 200 Index and exposure to market mispricing opportunities in large-cap companies.” So instead of investing in an entire index, you’d be putting your faith into the investment team at Wilson to select companies within the ASX 200 that will ideally outperform the index. However, this comes with higher fees than an index-tracking ETF and the legal structure of an LIC is different from an ETF, amongst other things.

As you can see in the chart below, WAM Leaders’ portfolio at the end of March 2020 was more diversified across sectors than the ASX 20 Index, although it still favoured materials and financials.

WAM Leaders Portfolio by Sector

Data source: Company Presentation. Chart by author.

Should you invest in blue-chip shares?

Blue chips are a great place for beginner investors to dive into the market. Their businesses are already familiar to most people, making it easier to get started analysing them. 

New investors can get started investing in blue-chips with limited knowledge by buying ETFs, which make it simple and straightforward to capture the growth of the greater market without the skill and time required by a stock-picking strategy.

Nonetheless, before you start investing, it’s important to understand your financial objectives and risk profile. For instance, the stability and reliability afforded to blue-chip shares can often come at the expense of returns. Therefore, investors with a longer investment horizon may skew their portfolio towards more high-risk, high-reward growth-orientated shares. This is because the longer time period will help to smooth out the greater volatility associated with growth shares.

To get a good read on where you stand, go through our beginner’s guide to investing in ASX shares. It walks you through a wide range of topics such as establishing an emergency fund, asset allocation, and understanding your investment goals. However you choose to invest, it’s important to develop a strategy, stay the course, and stay Foolish.

Figures correct as of 28 April 2020. Cathryn Goh contributed to this report and as of 28 April 2020, owns shares of Amcor PLC and BetaShares Australia 200 ETF. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. owns shares of CSL Ltd. The Motley Fool Australia owns shares of and has recommended Amcor Limited, Macquarie Group Limited, and Telstra Limited. The Motley Fool Australia owns shares of Transurban Group, Wesfarmers Limited, and Woolworths Limited. The Motley Fool Australia has recommended Scentre Group. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.