The term “blue chips” in Singapore is often used to describe the 30 companies which make up Singapore’s stock market barometer, the Straits Times Index (SGX: ^STI). It’s also a term that carries plenty of positive connotations for investors here in Singapore – and that’s dangerous for investors as it can easily lead to complacent behaviour. Thing is, whether a company’s a blue chip or not tells us nothing about how strong its business is. And since the performance of a firm’s business over the long-term is the main arbiter of how its stock performs, a company’s blue chip status,…
The term “blue chips” in Singapore is often used to describe the 30 companies which make up Singapore’s stock market barometer, the Straits Times Index (SGX: ^STI).
It’s also a term that carries plenty of positive connotations for investors here in Singapore – and that’s dangerous for investors as it can easily lead to complacent behaviour.
Thing is, whether a company’s a blue chip or not tells us nothing about how strong its business is. And since the performance of a firm’s business over the long-term is the main arbiter of how its stock performs, a company’s blue chip status, by extension, contains very little useful information on how well its stock might do.
A peek behind the curtain
To understand why this is so, we have to look at how the STI is constructed.
The latest incarnation of the index was launched in January 2008 after three firms – newspaper publisher Singapore Press Holdings, stock exchange operator Singapore Exchange, and British-based stock market indexes specialist FTSE – came together to create it.
Here’s how the creators describe the index: “The STI comprises the largest 30 companies by full market capitalisation that meet stated eligibility requirements.” The eligibility requirements in turn, depend largely on a company’s free float as well as the trading liquidity of its shares.
Shares of a company that are considered to be of the free float variety are essentially shares which are not controlled by a company’s insiders and/or strategically important shareholders. In other words, the free float are the shares that are available to be freely traded by members of the general public.
In the document I linked to earlier from the STI’s creators, there’s no mention at all that an index component is selected based on how strong or sustainable its business is; there’s also nothing in the STI’s inclusion-requirements which can give us information about how fast or possible a company may be able to grow its business in the future.
You can thus see that characteristics which have strong influence over the movement of a stock over the long-term cannot be determined by whether a share’s a blue chip or not.
Losing blue chips
Over the last eight years since 2007, the blue chips Golden Agri-Resources Ltd (SGX: E5H) and Noble Group Ltd (SGX: N21) have produced uninspiring business performances to say the least.
Source: S&P Capital IQ
As you can see from the table above, Golden Agri-Resources’ operating income, free cash flow, and returns on equity have fallen drastically since 2007. This has happened even as the firm’s balance sheet has deteriorated (alluded to by the increasing net-debt position). Meanwhile, what we’ve seen with Golden Agri-Resources can largely be applied to Noble as well.
With the above in mind, it’s not hard to see why both companies have been big losers in the stock market over the past five-plus years since the start of 2010 even though they’ve been part of the Straits Times Index over that time frame. You can see how the shares of both companies have performed below:
Source: S&P Capital IQ
Billionaire investor Warren Buffett once said that “If a business does well, the stock eventually follows”. The reverse is true too – the price of a stock will suffer if its business performance declines.
A Fool’s take
The blue chips we have now are some of Singapore’s largest listed companies. But they’ve become blue chips predominantly due to their large market capitalisations. This tells us nothing about how their businesses may perform in the years ahead, which is what really matters.
Don’t become complacent with a share thinking that it’d be a safe investment with a little chance of losing money just because it’s a blue chip. As it is with any other share, blue chips that have a deteriorating business likely deserve to fall in price as well.
Always look at the value and future prospects of a share’s business price before making any investing decision.
Is there anything more you'd like to discuss regarding blue chip investing? If so, you can come meet David Kuo and the rest of the Fool Singapore team on August 15!
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any companies mentioned.