Many times the average investor has come across the idea that investing in “blue chip” stocks are safer or more conservative. A blue chip stock is stock of a well established company with stable earnings and no extensive liabilities. Often, they pay dividends, and are recognized nationally or internationally. Many times they also have a large market capitalization (market value) and are included as part of a major stock index. Blue chip stocks are associated as being high quality stocks. However, this is a dangerous misconception. Lets explore why.
Stable earnings today or in the past, does not necessarily mean that earnings will continue to be stable into the future. Earnings largely depend on consumer and economic trends. No extensive liabilities, does not mean large business risks are not being taken. Business decisions that introduce large risk usually do not make it into the balance sheet until it is too late. A company that pays a dividend does not mean that they will continue to do so. We have seen many companies who eliminated their dividends, as they could not pay them out of their cash flow. National and international recognition is meaningless if it does not translate into profits.
Lets look at a few examples of some stocks that once had all the criteria of “blue chips” :
– Washington Mutual – Was a savings bank holding company, which was largest savings and loan association, and 6th largest bank in the US. In June 2008 total assets were $307 Billion US. It became the largest bank failure in US history on September 25, 2008. Washington Mutual was recommended as an investment in Forbes Magazine in 2006!
– Bear Sterns – Was a global investment bank, until its failure May 30, 2008 in a fire sale to JPMorgan Chase. In 2005-2007, Bear Stearns was recognized as the “Most Admired” securities firm in Fortune Magazine’s “America’s Most Admired Companies”.
– Lehman Brothers – Was a global financial services firm with $19.2 Billion US in revenue. On September 15, 2008, the firm filed for Chapter 11 bankruptcy protection.
– General Motors – GM manufactures, services, and sells, cars and trucks in over 140 countries. Recently the company employed over 244,500 people around the world. In 2008 they had the third highest global revenues among automakers on the Fortune Global 500. On June 1, 2009, General Motors filed for Chapter 11 bankruptcy protection, and has become majority owned by the US government.
– Dell – Is one of the largest technological corporations in the world, and was listed #38 on the 2010 Fortune 500 list. In recent years, Dell has been hit with quality/reliability issues as well as customer service problems. It once held the position of #1 desktop PC and #1 laptop maker. But due to eroding profits, those positions are now held by HP and Acer (the current top 2 makers in both categories). In June 2010, founder Michael Dell said he has considered taking the company private.
– Nortel – Nortel Networks Corporation was a well known global telecommunications equipment manufacturer, that employed 94,500 worldwide. It had a market capitalization of $398 Billion CDN in September 2000. At its height, Nortel accounted for more than a third of the total value of all the companies listed on the Toronto Stock Exchange (TSX). On January 14, 2009, Nortel filed for bankruptcy protection in the US, UK, and Canada. In June 2009, the company announced it would cease operations and sell off all of its business units. Nortel was once recommended by professionals as an investment in almost all Canadian newspapers, magazines, and investment talk shows.
Clearly, being considered a “blue chip” stock/company means very little. We should also remember that all great companies were once small start-ups. When investing, investors should stick to companies they know, and whose businesses they understand. The management of those companies should be honest & open, have a sizeable ownership stake in the company, focused on creating long term shareholder value, and should not display behavior consistent with the institutional imperative. The CEO’s leading the companies should also display taking personal responsibility for both positive and negative results. These qualities are much more important than being labeled a “blue chip”.