Fading blue chips

The term blue chip, in relation to stocks, was first coined by Dow Jones reporter Oliver Gingold around 1923. It was a reference to the highest value poker chips (which represented a bet 25 times that of the white chips). Seeing companies with stock prices of $200/share, he borrowed the gambling term to reference these companies with the lofty share prices.

Blue chip has come to mean old, established and profitable but really, that is a misunderstanding.

Investors today think of Coke (US$41/share), GE (US$25/share), Walmart (US$76/share) and the like as blue chips. Yet the stock prices for these companies would surely not qualify under Gingold’s definition when compared with Google (US$544/share – after a one-for-one bonus), Apple (US$102/share after six-for-one bonus) Netflix (US$383/share) or Amazon (US$313).

Blue chip has come to mean old, established and profitable but really, that is a misunderstanding of the original term, which was just about price.

This isn’t just a history lesson, it’s history that is now being written. As the Wall St Journal noted yesterday, “blue chip” companies are turning in some of the worst earnings performances of the season – Coke’s third quarter disappointed on almost every metric, AT&T lowered its revenue forecast, IBM fell 10% after it admitted that its revamped business plan was way off track and forecast a drop in earnings, and Procter and Gamble said it was looking to cut unprofitable brands – surely a bad sign in a business where brand value is way more complex than just one shampoo’s profitability.

S&P Capital IQ posted data showing a third of the companies in the Dow Jones Index posted shrinking or flat revenue over the past year. And revenue growth for almost half the industrials was lower than the US inflation rate of 1.7%.

In the local context, which companies are blue chip, in the sense that investors really mean the term – ie strong earners that are well established (rather than just high stock prices)? Telstra? The banks? BHP?

Telstra CEO David Thodey himself has acknowledged the difficulty of trying to remake the business in a world of rapidly changing technology.

Telstra CEO David Thodey himself has acknowledged the difficulty of trying to remake the business in a world of rapidly changing technology. Telstra has already ceded huge amounts of value to Apple and Google (mobile minutes and data continue to commoditise, Sensis is all but dead because of Google).

Thodey is trying to remake the business as a nimble start-up investor and a reseller of services on the NBN, but the jury is out on both of these. Even if they are successful, these two are unlikely to be large enough to justify a growth multiple. BHP Billiton is splitting into two companies to unlock value.

The issue for these “blue chip” companies is that they have legacy systems, entrenched cultures and outdated business plans that work against enhancing shareholder value. BHP’s model of selling commodities to China is under serious pressure as China’s growth slows. And as it slows, it is more likely that Alibaba’s (US$91/share) model of commerce will outperform relative to bricks-and-mortar retailers. Which will make BHP’s growth even slower (since it supplies to the iron ore to build the malls).

In the face of this, is it any wonder that the new blue chips (again, not as originally defined ie those with high stock prices) are companies that are the product of changes that have swept the world through better technology – technology that collapses antiquated supply chains and opens up channels which previously didn’t exist? Companies like Seek (16/share), Carsales (A$10/share) and Cochlear (A$72/share).

My own prediction is that the shift in value out of the fading “blue chips” will accelerate, as technology enables new businesses which will take share from incumbents. The resurgence that we saw post GFC into consumer staples like Walmart and AT&T is now unravelling. And the new blue chips, like Google and Alibaba, are unlikely to be other than bit players in any future tech-wreck – more likely is that they will be the new winners. Which means, of course, that they will be the ones writing the history…