Many investors are under the impression that one cannot make a lot of money investing in blue chips. The predominant feeling is that blue chips are well researched and hence any information regarding the stock will already be out in public. Therefore it is difficult to get the information edge. In fact, this website also advocates looking for neglected, well-valued firms which by definition rules out blue chips from the start.

But whilst it is true that it is difficult to get the information edge on a blue chip, this does not mean that you will not be able to make money from them. Before we go onto explain why, we will explain why it is important that investors do not neglect analysing blue chips.

The one advantage which blue chips have over small caps is that they are more difficult to manipulate and hence more properly priced compared to small caps. By studying why a blue chip is priced as it is, you can get a lot of information on what the investment community is valuing at the time. Is the company valued at such because of good management? Core product? Dividend yield? Government linked? By doing this exercise over several companies, one will be able to derive a pretty good understanding of the values which are currently in vogue in the investment community. Then, it is possible to apply such values to smaller caps to see whether they stack up. If a small cap shares the same qualities as the blue chip, then you will be able to say that the small cap is relatively undervalued.

But, I digress. Blue chips have another property which is important. They are usually more highly correlated to the KLCI due to their larger market caps. This is important for risk management purposes because whilst it might be beneficial to invest in small caps and participate in the chance that they may explode upwards, you may not want to risk all your money on these small caps. By keeping a significant amount of money in a basket of large caps which are highly correlated to the KLCI, it is possible to reduce the overall volatility of your portfolio and hence your sanity if prices start to move drastically. After all, getting rich involves not only being able to pick good stocks, but also managing your risk/reward ratio when things go crazy.

Conclusion: Blue chips are an important way to manage your risk/reward ratio and give you an accurate idea of the values or factors favoured by investors.