Stock market investments and risk are inseparable combinations. Due to exposure to a large sea of investors, the difference in their perceptions causes volatility in the market. However, there are some companies which stay firm even during such volatility. It may be affected for a short period, but overall, the effect is adjusted in the longer run.
The companies with robust operations and business networks are the ones profitable in the long term. Due to their potential market share they are called blue-chip stocks. However, these stocks also have high costs, due to better market expectations.
Investing in a blue-chip stock can help investors have a firm, less volatile investment. It also helps in taking more risks while diversifying. The investing process is preceded by a holistic analysis of that stock and company. Here is the list of 5 key metrics that can help analyse blue-chip stocks.
What are blue-chip stocks?
The stocks with robust and consistent market performance, high market capitalisation, and low volatility-prone nature are considered blue-chip stocks. Usually, these companies also have efficient business operations and market share. The word ‘blue-chip’ originated from the most valuables in poker.
However, the term is wide enough and doesn’t have a specific categorisation in India. The Securities Exchange Board of India or SEBI has prescribed only three types of stocks based on market capitalisation ranks:
- Large Cap: Top 100
- Mid Cap: 101 to 250
- Small Cap: 251 onwards
Therefore, blue-chip stocks are used synonymously with large-cap stocks. These companies are characterised by stable earnings, dividend payments, high investment costs, low volatility, etc.
Merely understanding what are blue-chip stocks may not suffice. Investors need to keenly analyse them before investing.
Explore more: blue-chip Stocks: Meaning, Key Features, and Why They’re Considered Safe
Metrics to analyse blue-chip stocks
There are many important aspects for analysis in the stock market. However, 5 of these are listed here, which can be specifically used for blue-chip stocks.
- Financial stability
These stocks are investments with a long-term outlook. Thus, understanding its financial position is crucial. Mainly earnings, expenses and cash flows are considered in this. However, their absolute value may not indicate a clear picture. Investors can calculate its effect in comparison with sales and derive margins.
- Earnings: Net profit, operating income, asset turnover, gross profit, etc.
- Expenditure: Operating costs, finance costs, depreciation and amortisation, raw material expenses, etc.
- Cash flows: that from investing, financing and operating activities.
Investors can also check the turnover ratios to understand the nuances of the company’s performance Moreover, consistency and factors affecting the earnings should be checked.
- Debt levels
Debt becomes a crucial part of capital in the growth stage. Therefore, procuring debt is important. However, planning its repayment and other obligations is equally important. Investors can check the company’s debt management with the following ratios:
| Ratio | Formula | Description |
| Interest coverage ratio | Earnings before Interest and Taxes / Interest | It indicates the company’s ability to manage its finance cost against the earnings. The higher ratio is better. |
| Debt servicing ratio | Net operating income / (Interest + debt) | It also indicates a company’s total debt service against its operating income. A higher ratio is better for the company, and less than one can be alarming. |
| Debt to equity ratio | Total debt/ total equity | It is the ratio of a company’s capital structure. The lower this ratio, the better the capital structure. |
- Dividend payment
A company with a stable financial position is expected to roll out dividends from their profit. It is not a mandatory expense for the company. However, it is a crucial indication of better performance and investor relations. Investors can check the dividend payment frequency and %. Usually, blue-chip stocks have better dividend distribution policies.
- Business viability
A company’s products, management team, network, market share, etc., can be a part of qualitative factors for analysis. Usually, blue-chip stocks are big companies and have better market positions. Their products, services, management teams and owners are well-known in the market. They may also have a multi-national presence. The industry of blue-chip stock also plays a crucial role.
- Technical price movement
Usually, technical details are considered for the short-term trading process. Analysing technical aspects can help investors ascertain entry-exit prices, investor sentiment, future valuations, etc. Investors can check the aspects like:
- Yearly stock price movement, highs and lows. It will help investors decide on better market entry points.
- Indicators like moving averages can help analyse the blue-chip stock charts. These are easily available in the brokerage firm’s applications and websites.
- Intrinsic value indicates the potential price investors are willing to pay. However, its calculation can be complex. Investors can use ratios like price to earning or price to book value to determine the overvalued or undervalued blue-chip stocks.
These are basic technical aspects that can help investors analyse the stock price.
Dive deeper! Mastering Share Valuation: Methods and Key Factors Explained
Conclusion
Blue-chip stocks are the instruments with potential market capitalisation, less prone to market volatility and consistent financial performance. They have high demand among the investors, which increases their market price. Analysing financial performance, dividend payouts, business viability, debt and technical price movement can help investors make an informed investment decision.
Also, read Large Cap vs Small Cap vs Mid Cap Stocks: A Comprehensive Guide
FAQs
- What is the key characteristic of blue-chip stocks?
The high market capitalisation is a feature that separates blue-chip stocks from other stocks. Investment in such stocks is usually less volatile as the companies are established brands in the market. They are expected to deliver higher market returns and distribute dividends as they are financially sound.
- Why do people invest in blue-chip stocks?
They are one of the most accessible ways to gain potential market returns with moderate volatility. The cost of investing in these stocks is quite high but they also have the potential to perform better than others. The blue-chip companies are usually well-established businesses.
- What is the price-to-earnings ratio?
It is a valuation indicator for a company’s stocks. It calculates the price paid by investors to earn 1 unit of return. Investors usually consider this ratio to check whether a stock is overvalued or undervalued and ascertain its market potential.
- What is intrinsic value?
It indicates the amount an investor is willing to pay for a stock based on its risk level. It is calculated with the help of discounting expected future cash flows. However, its calculation can be complex and would require accurate assumptions.
- How to calculate the interest coverage ratio?
The interest coverage ratio is the indicator of a company’s debt-paying ability. It is calculated by dividing the earnings before interest and tax by the interest expense. This ratio above one is considered positive as interest expense is payable against the debt levels.
