Best blue chip stocks to buy for long-term; check how to track multibagger stocks

The easiest way to track what could help stocks have a long runway of superlative returns is to find qualities in their quantitative characteristics

By Tanushree Banerjee

Until the 1990s, the fortunes of the Indian cricket team rested on the shoulders of the star batsmen, be it Pataudi, Gavaskar or Tendulkar. They were the stars who won matches. And without them the team fell like a pack of cards. In the stock markets, the fortune of the benchmark indices has come to rest of few star performers over the years. The bulk of the investor money comes to them. And investors firmly believe that only these stocks could create wealth over the long term. But the fact is the performance of index stocks will, at best, trail the index over the long term.

So, if you are looking to make big gains in blue chips over the next decade, then you need to look beyond the Sensex stocks. You see, a lot of the quality blue chips are not just restricted to the Sensex alone. If you widen your horizon a bit and look at let’s say, the BSE 200 index, then there are quite a few bluechip stocks that are set to deliver handsome gains over the long term.

Look out for these key characteristics of multibagger blue chips

The easiest way to track what could help stocks have a long runway of superlative returns is to find qualities in their quantitative characteristics. And here they are:

1. Capital efficiency: The companies are able to generate consistently higher returns on their shareholders’ equity. The idea is the more profitable the company gets, the more value it will create.

2. Low leverage: Minimal debt (debt to equity ratio) is extremely important for companies to tide over periods of tight liquidity and high interest rates.

3. Profitability with low capex: Companies that have already done the hard work of building plants and machinery for future growth, are typically in a ripe phase to benefit from their efforts.

4. Scope for PE expansion: Stocks with low PE multiples tend to have a huge room for PE expansion if the business and management went in the right direction.

If I must pick just one characteristic or ingredient that has been the key catalyst of these multibagger stocks, it would be their PE expansion. Larger the PE expansion higher has been the quantum of returns for the top multibaggers.

Here is the data to prove my point…

Data source: Ace Equity

The top 100 odd companies which gained up 1000% have had extraordinary fundamentals. But what really made the difference between them and the 10,000% gainers was the quantum of expansion in PE multiples.

Technology catalyst can be a gamechanger

Technology has the power to change lives over time. Imagine a world in the future where an autonomous vehicle picks you up for work. It plays your favourite playlist. And it makes a quick stop for your morning coffee. All this, without you having to reach your wallet or your phone. This is how devices enabled with Internet of Things (IoT), could transform our everyday lives.
The reason this technology is so important is because it could transform the future growth rates of multiple business. When I say that I mean businesses as diverse as healthcare, automobiles, financial services, retail and agriculture.

Now, as an investor looking for exponential profits over next few decades, you cannot settle for the usual stock screener. You cannot just look for tried and tested businesses. Or the most popular brands. Rather you need to look for stocks where technology is acting is a huge catalyst of change that could offer exponential earnings growth in the years to come.

Blue chips aren’t always ‘One direction stocks’

A headline in The Wall Street Journal called Kodak and few others ‘one direction stocks’. Investors, big and small, loaded up on them. The PE ratio reached insane levels. At the peak, the index traded at a PE multiple of 94 times! Then, just like all bubbles before and since…the bubble burst. Some Nifty Fifty stocks lost up to 75% of their value. Kodak eventually went bankrupt.

When I run my screens for bluechip stocks in India, I find that it is rare for the NSE Nifty to trade at a valuation above 22x. And when it does, buying even the biggest blue chips has come with a huge downside for long-term investors.

So, the historical data suggests whenever the Nifty trades above 22x, there is typically a 60-70% chance of losing money even in blue chip stocks.

But wait!

You cannot buy the best blue chips by following index trends. Rather, you need to take a contrarian view on the best blue chip businesses. For the past fifteen years, I have told Equitymaster subscribers to buy blue-chip stocks with a safety-first approach. Always.
In StockSelect, I recommend blue chips when the downside risk in valuations is negligible.

But there are also times when the market completely misses out on the earnings trend. The earnings upside itself makes some stocks inherently safer. At such times, it doesn’t take a genius to figure out where the odds are better.

Which are the best blue-chip stocks to buy now?

Well, buying the best blue chip stocks does not mean picking a few from the benchmark Sensex or Nifty-50 index. Neither does it mean buying a bunch of heavyweights and holding them forever. Rather the best blue chips are those that not only help you create but also conserve wealth over decades. For that the companies must consistently grow and consistently add value.

So, be careful and consistent in evaluating both the quality and valuations of stocks. And do not hesitate to buy more of the sound bluechip stocks that you already own, from time to time.
I strongly believe that this framework offers one of the safest ways to create long term permanent-wealth with blue chip stocks.

(Tanushree Banerjee is Co-Head of Research, Equitymaster. Views expressed are the author’s own.)