Blue-chip companies are often prized for their stability and are established businesses.
These companies are categorised as such because of their size and long track record of financial performance.
Investors who desire consistency tend to park some money in blue-chips over the long-term, as these companies are expected to provide steady growth and regular dividends.
A simple way to classify a blue-chip company is to review what makes up the key index for each country.
For Singapore, the components of the Straits Times Index (SGX: ^STI), or STI, provides a list of what’s considered blue-chip.
In the US, it would be the Dow Jones Industrial Average (NYSE: ^DJI), or DJIA.
But if blue chips are consistent, then shouldn’t you invest only in this select group of companies?
Falling on hard times
Even the most established businesses are not infallible.
They are made up of businesses whose fortunes can ebb and flow with the economy. The health of the business will also depend on whether their goods and services stay in demand.
Meanwhile, two events have emerged that have threatened some of our local revered blue-chip companies.
One is technology disruption, where digitalisation has caused a permanent shift in the way certain industries work.
A good example would be the emergence of ride-hailing companies such as Uber Technologies (NYSE: UBER) and Grab.
These new services, which make use of smartphones to allow private car owners to double up as taxis, have interrupted the business of ComfortDelGro Corporation Ltd (SGX: C52).
The other matter, of course, is the COVID-19 pandemic.
With many countries imposing lockdowns and border closures, blue-chip companies such as SATS Ltd (SGX: S58) and Singapore Airlines Limited (SGX: C6L) have reported severe losses.
Thus, blue-chips are not immune to both disruptions to their business models, as well as economic crises.
Even for the DJIA, nearly half of the companies that were part of the DJIA twenty years ago are no longer in the list.
Some of them don’t even exist anymore.
These examples show that investing in blue-chip companies does not guarantee investment success.
The allure of being smaller
Smaller, mid-cap companies may offer better prospects and a longer runway for growth.
Such is the allure of being small and nimble.
Some businesses may have a proven business model but have not attained the scale required to be included in a major index.
If you were to only include blue-chip index companies within your portfolio, you will inadvertently miss out on these opportunities.
Being smaller may also translate to having larger growth potential, as the company’s revenue will start from a smaller base.
In mathematical terms, it is easier for a company to grow its revenue from $1 million to $10 million, than it is to grow sales from $1 billion to $10 billion, all things being equal.
Casting your net wider
The advantage of looking outside of the blue-chip universe is also to capture opportunities present in other sectors.
The STI consists mainly of banks, telecommunication companies, REITs and property companies, along with a smattering of other businesses.
However, the pandemic has shown that sectors such as glove manufacturers can do extremely well.
Supermarket operator Sheng Siong Group Ltd (SGX: OV8) and financial technology company iFAST Corporation Limited (SGX: AIY) have also remained unaffected, and have both thrived through the crisis.
The above-mentioned sector and businesses are not classified as blue-chip companies, even though they’ve done well and remained resilient.
By venturing outside the blue-chip space, you will have an opportunity to diversify your industry exposure and capture some of this growth.
Get Smart: Diversify, but understand the risks
As an investor, you should learn to cast your net wider and not be limited to just blue-chip companies.
It’s important to diversify your holdings as larger, well-known companies may lose their edge and face insurmountable challenges.
However, a word of caution is warranted.
Smaller companies may have their merits, but you should also understand the risks involved.
By virtue of their smaller size, they are generally more vulnerable and are more affected by external forces than the larger companies.
Knowing this, you may wish to size your position smaller when it comes to non-blue-chip companies.
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Disclaimer: Royston Yang owns shares in SATS Ltd and iFAST Corporation Limited.