For most investors Australian blue chip shares should make up a core portion of the investment portfolio. The relative weighting in the portfolio compared to growth, dividend stocks and even other asset classes like bonds and real estate depends on the risk tolerance and investment horizon.
What are Blue Chips Shares?
Blue chips in the investment landscape are stocks of companies with household names and considered rightly or unfairly as some of the safest stocks on the Australian share market. There is always a risk in buying shares as long term investment returns are dependent on the risk the investor takes. There is no such thing as a free lunch. In most instances, the higher the return means investors are taking on greater risk.
Australian Blue Chip Companies
Ostensibly all companies on the ASX 100 list can be called blue chips.
Examples of blue chip companies include BHP (ASX BHP), Big 4 banks like NAB and CBA and infrastructure companies like Transurban and APA. But only because a company is considered a blue chip does not mean that it is not susceptible to external factors that could impact its performance.
BHP earnings are still dependent on volatile commodity prices like iron ore prices and copper. We saw what happened to retail shipping center owners like Westfield when Covid hit when many of its specialty retailer tenants stopped trading and importantly they stopped paying rent. Likewise, the major banks are still susceptible to the property market, employment and interest rates.
The point is that only because the company is considered a blue chip company does not mean it is a good investment. Sometimes because of a combination of their scale, size of the balance sheet and diversification of income, its earnings and return to investors through dividends can withstand short term shocks and more likely to bounce back from any setbacks.
The Australian banks are still here after surviving the financial crisis where at the same time several smaller companies went out of business. BHP/RIO bounced back after the end of the last commodity cycle while many smaller less well capitalized miners (too many to name!) went out of business.
List of Blue Chip Shares
This is a small list we came up with most from the ASX 20 after adjusting to include 2 of the big 4 banks and added more healthcare focused companies.
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Benefits of Owning the Well Known Names
Usually, a company becomes one of the largest ASX blue chip shares because the underlying business has a moat or advantage over its competitors.
Examples of blue chip shares include the big 4 Australian banks, where they came out of the financial crises stronger than ever. They are in the position today because of the industry oligopoly structure. The smaller Australian regional banks and foreign banks in Australia have failed in chipping away the larger banks’ market share and the winner gets bigger.
A killer industry structure that clearly benefits the incumbents means that the quality of earnings is less volatile. The key for the management need not to mess it up. Other examples of blue chip shares with similar characteristics are Telstra, Transurban and BHP/RIO in iron ore.
Not all companies got to where it is today by limited competition. Most got to where they are simply because they are better run, better in executing a strategy and creating long term value. Wesfarmers instance especially comes to mind here.
One of the most important metrics we use in evaluating an investment is also one of the most intangible factors: management judgment.
Secondly, the listed market shows a strong degree of survivor bias. Companies that are better run than their competitors and withstand the test of time by definition remain continually listed and rose to the top.
What is Blue Chip Shares – Our investment approach
We don’t invest based on the companies reputation. A company is well known, has a global reach and is a household name does not mean it is the best ASX stock to buy now and even be considered in our portfolio.
We are a fundamental or value investing school of thought.
Each position’s merits in our portfolio are based on the attractiveness of current valuation, quality of management, future business and industry prospects.
Some key perspectives in analyzing a company include:
1. Business quality – is the company one of the best in the industry? Does the management have a track record of strategy execution?
2. Earning sustainability – earning stability does not mean predictability buy refers to if the company is able to sustain or repeat the earnings over the long run.
- After establishing that the business has a solid foundation, the key question is to consider the industry’s structural headwinds.
- What is its value proposition and growth in the total addressable market? This means that if its earnings are cyclical flow and ebb with the market like real estate development, earning sustainability, the annuity nature and its comparative advantage of adding value throughout the cycle.
3. Solid financials – If a company is well run from the business side, are we comfortable with its capital structure? Over leveraged balance sheet is a strikeout from the start.
The perception of safety usually means investors are willing to bid up the stock and usually trades at a premium to the market. However, overpaying assets given the risks does not usually end well.
An example of this includes Woolworths in 2015. The company’s performance has been atrocious due to its inability to run the business with a long-term view even though the Australian consumer staple industry is dominated by 4 major players Coles, Aldi, IGA and Woolworth. While we disagreed with the Master’s business exit, the current management has brought stability and direction to the company. The share price performance reflects the positive momentum seen in the business.
At first glance, the bias towards safety makes blue chip shares attractive for most investors, but most investors do not dig further than the skin. There are several businesses we like to own but are too expensive for our taste. We follow them so we have done our homework and be ready for the next market sell offs to pull the trigger. After all, investing in its simplest form is buying low and sell high.