High beta versus blue chips in bull run

In a bull market, like the one that we are currently seeing, investors are overjoyed with the spectacular returns they are seeing on their screens. This is true especially in the post-pandemic when global banking regulators have printed a lot of money leading to a bumper spending and therefore a boom in equities. The conversation then is whether one's returns are better than of others. And that is tricky. Returns are also a function of the risk you take and the stocks you choose. That is where a comparison between high-beta stocks and blue-chips kicks in into conversations. So, what exactly are these high-beta stocks and blue chips?

What are high-beta stocks?

Beta is typically used to assign a sort of sensitivity to a stock. Markets regulator Securities and Exchange Board of India (SEBI) says beta is a measure of the volatility of a stock relative to the market index in which the stock is included. Therefore, a low beta indicates relatively low risk; a high beta indicates a high risk. While the stock market itself is linked to many variables a stock is often measured based on its propensity to respond to this overall market. For example, does it drop significantly more or significantly less or in line with a broader market correction? Does it go up significantly overtaking the broader market returns? The latter makes up for all high beta or as many often call them high-risk stocks.

What are blue chips?

If you are familiar with the class toppers in your school and the love the teachers shower on them and keep some of them ready to be the head boy and head girl you know blue chips already. These are the blue-eyed boys and girls of the stock market who have delivered exceptional value to their shareholders over the years. They are already “discovered.” Markets regulator SEBI has a more condensed but all-encompassing definition: the best-rated shares with the highest status as investment based on return, yield, safety, marketability and liquidity. One will often notice that this tag is awarded to such companies that have grown really big, pay good dividends, are seen constantly innovating and improving their earnings, have very stable debt levels, strong management and sometimes a moat that keeps people going back to using or buying their products and services. India’s blue-chip universe includes the likes of Tata Consultancy Services(TCS), Infosys, HDFC Bank, ICICI Bank, State Bank of India, ITC, IndianOil among others.

How did the term blue chip come into prevalence? 

Oliver J. Gingold, editor of The Wall Street Journal's "Abreast of the Market" who died in 1966 at the age of 80 noticed some stocks trading at around $200 and told his colleagues that he intended to return to the office to "write about these blue-chip stocks". In the US, the term blue chip was often used for things with higher values just like one uses terms like royal blood or pedigree. This has become the go-to expression for the best of companies since then. These stocks also differ from high-beta stocks in that they are more resilient in grim stock market cycles but at the same time may not soar like them in a bull run. For the same reason, they also have more buyers and therefore are expensive in that they have a higher Price-to-Earnings or PE ratio.

What is a bull market?

Technically, a bull market is an increase of 20% or more in a broad market index like the S&P 500 or Nifty from its previous low. A bull market is typically the phase of the stock market where stocks are soaring and a lot of money is pouring into them showing increased investor interest and appetite of shareholders about the buoyancy of the economy and the company's ability to earn more and profit more. The opposite is said to be a bear market when people fear poor earnings, low liquidity and economic recession and look for stable options like bonds fixed deposits and gold as assets to own.

Pros and cons of high-beta stocks

These stocks typically have a special character. For example, in a market where the regulators are cutting interest rates and controlling the supply of money, they may not perform as much. Conversely, they will shoot up when interest rates are cut and there is more liquidity. They also typically fall much more – like a waterfall – during bear markets or during corrective phases of the market relative to the overall market. They are also prone to wild swings – rising to give you great profits but sliding suddenly and making the screen red. Many conservative or value-oriented mutual funds often avoid such stocks in their portfolio but some thrive on them and therefore offer chart-topping returns. Interestingly some of these latter funds (if they are sizeable) churn their portfolio often and this high churn rate can also impact some of these stocks both positively and negatively. High beta stocks also often tend to come from new-age or cyclical industries and can be favourites only to fall out of favour if there are sudden external tweaks or policy changes. These stocks are also often not great dividend paymasters and can wobble on whispers etc. In a sense, they are the darlings of speculators. Suffice it to say they bring in the money but can also set one back if the choice is not well 

thought out.

Which is better in a bull market

There is no straight answer to this. Blue chips ideally remain the core of a portfolio typically but those who are experienced in how the markets work, understand the economy well, can read balance sheets and keep an eye out for analyst calls and management speak, may prefer high-beta stocks during a bull run. 

Conclusion

High-beta stocks can bring you higher returns but one will need to follow these firms carefully to avoid a gash in your portfolio when things become volatile. For that reason, they are very attractive and also keep people hooked to researching and tracking them. On the other hand, blue chips may not yield high returns in short time, but they may be safer in times of turbulence.