Why blue chip stocks are preferred?

Price movement of a Share and Investment Decisions:

It is true that it is very difficult to predict the price movement of a stock of a listed Public Company. The price of a share of a listed Public Company will depend upon the ‘demand and supply rule’. It depends upon the simple fact as to how many are bidding to purchase a particular stock and how many are proposed to sell that stock in a given period.

But, the problem is that the investor and especially retail investor may not look at the fundamentals of the Company and may not think logically. We see many investors and especially intra-day traders and the retail investors who will invest in the Company based on the movement of the price of a particular stock as shown in the graph and other mode from the website maintained by the stock-brokers or the concerned Stock Exchanges. With these investors who bids to purchase shares based on the price movement only, it becomes very difficult to predict the share movements based on the fundamentals. A Company may have strong fundamentals, but, still, the price of the share may go down. A new Company’s share may go up unreasonably though we yet to see the fundamentals and yet to see the functioning of the Company. It all appears to be confusing.

If the Company is in a position to make profits, then, we can invest in such a Company and it is the fundamental thing an investor should consider while attempting to invest in a Company. But, how to find as to whether a Company can make profits or not? It’s a difficult issue and even the predictions of the management of a Company may go wrong at times and every Company wants to make profits unless the formation of the Company is itself with the ill motive of cheating the investors.

We should consider the perspective of investors as follows:

Strategic Investors: These are Companies or entities who will invest in a particular Company with a strategy and given the limitations prescribed under SEBI (DIP) Regulations and the Takeover Code. These strategic investors will have a clear plan supported by research while making a strategy to invest in a Company either through Secondary Market or through Share Purchase Agreements or Mergers. A Company may not have an instant profit motive while making a strategic decision to invest in a Company. A Company may want to expand its business and may like to penetrate into the market through acquisitions and mergers and these companies invest though there is no scope for instant profit motive.

Institutional Investors like Mutual Funds: These institutional investors focus on profits only. They do lot of research while taking an investment decisions and will be having a diversified portfolio as they always try to reduce the risk.  These institutional investors invest the funds of others logically and as such they are answerable. As the retail investor or an individual lacks the needed expertise to predict the price movement of a share and may lack the command over the fundamentals of a Company, they prefer to invest through institutional investors like Mutual Funds. 

Retail Investors – Short-term: There are individuals who do intra-day trading or make short term investments through Secondary Market. These individual or retail investors normally depend upon the advice of Stock-brokers and take investment decisions as such. There are few individual or retail investors whose primary job itself is making profits through trading and majority of these people will invest in a Company looking at the share movement through graph and other mode provided by the web-sites maintained by the Stock-brokers and Stock Exchanges. These short time investors may not have time to focus on fundamentals of a Company and their investment will normally be based on the price movement.

Retail Investors – long-term: These people try to adhere to fundamentals of a Company and do lot of research while taking an investment decisions. These people prefer blue chip stocks as making a long-term investment in blue chip stocks is secure logically.

What are the things to be considered before investing in a Company?

It is really difficult to conclude the issue as to what all the things to be considered while taking an investment decision. Normally, people will look at the track record of the Company, the sector, the management, future plans, the functioning of other group companies, the brand name, the opinions of experts, economic scenario in the Country, economic scenario in the word, the important policy decisions of the Government which are likely to effect the profit making of a Company. No one can conclude as to what all the things to be considered while taking an investment decisions. Certain decisions can be taken instantly. For example, when the share price of Satyam has come down to Rs.50 per share and even below that, it was prudent to make an investment in the Company at that time as the Company has good brand value, good clientele and even the effect of the scam may not lead to winding-up the Company or there will be other Companies who will takeover over the Company or evince interest to rescue Satyam and ultimately it has happened through Tech Mahindra.

Why blue chip stocks are preferred?

These blue chip Companies are big companies with very good market capitalization and they tend to have a brand value in the market and there will be many group companies. A big group never allows going its brand name down and they know that a bad instance in one Company will effect the prospects of other Companies too. As such, investors feel that investing in blue chip companies is safer though there can not be unreasonable price movements with a chance to make instant and big profits. Normally, long term investors and long-term retail investors prefer investing in blue chip stocks and these investment decisions are on logical footing.

Note: views expressed are my personal.