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Difference Between Blue Chip and Penny Stocks

20 Dec 2022 0 COMMENT

Introduction

Most investors understand concepts like blue chip stocks and penny stocks intuitively. The general understanding is that blue chip stocks are solid stocks that have proven their credibility and performance over the years. That is largely correct. But then penny stocks are less understood. For instance, not all low priced stocks are bad stocks. For example, stocks like Bajaj Finance, Lupin were all penny stocks at one point, before they became multi-baggers. That is something to understand in this penny stocks vs blue chip debate. Price is just one of the criterion, but penny stocks also have other qualities that make them more vulnerable compared to blue chips; like higher debt, concentration of customers etc. That is actually at the core of this Blue chip stocks vs penny stocks perspective.

Here we will look at the concept behind blue chip and penny stocks and what are the unique features characterizing them. The penny stocks vs blue chip stocks comparison is key to understand what should be your expectations when you invest in these stocks. At the end of the day where there are some visible differences between blue chip and penny stocks, investors are looking for value at the end of the day and that is much beyond whether the stock is small, large or medium sized.

What are Penny stocks

While there is no official definition of what is a penny stock, the definition in the Indian context is a stock that is trading at less than Rs50. There are some who give an extreme definition of stocks trading below par, but that is a very narrow focus on problematic penny stocks. As we stated earlier, not all penny stocks are bad and some of these penny stocks like Bajaj Finance, Eicher, Lupin etc are up more than 100 times in the last 15-20 years. But, penny stocks have some features like debt levels tend to be high, the companies are low on liquidity and the market interest in the stock is low. Also, the business model of these penny stocks tend to be vulnerable due to dependence on a handful of customers or markets.

Typically, the penny stocks that break through these challenges and emerge stronger are the ones that become multi-baggers over time. But a large majority of penny stocks do have the tendency to destroy value, which is why investors have to be careful. Some of the features of penny stocks are high speculative volumes, high levels of price volatility etc.

What are Blue-chip stocks

Blue chip companies, as the name suggests, are companies with strong brands, profitable track record of at least 15 to 20 years, demonstrating consistent growth and healthy margins. Blue chip companies are regarded safe as they are normally market leaders in their specific industries or niche segments and hence they get the benefit of entry barriers. Many of these blue chip stocks are the ones where investors feel confident to buy on dips as the general perception is that the blue chip stock would eventually bounce back.

Not all blue chip stocks are market outperformers. In fact, most of them give around market returns, so don’t expect multi-baggers in blue chip stocks. But, investors can be rest assured that their capital is safe and will eventually grow over a longer period of time, since these blue chip companies can handle market cycles much better. While some are blue chips due to consistent growth and high margins; others are blue chips because they are cash cows and have consistently attractive dividend yields.

Blue Chip Vs Penny Stocks - Key Difference

Having understood the concepts of blue chips and penny stocks, here are some key differences between them to be understood.

a)  In terms of long term returns, blue chips tend to offer stable index linked returns over a longer period of time. Penny stocks come in a wide variety, but the better ones among the penny stocks can be multi-baggers over the long term.

b)  Most penny stocks tend to be riskier compared to blue chip stocks as they have a concentration of clients or of markets. Blue chips have more diversified business models and stronger brands making their business model more stable.

c) Generally, blue chips tend to be better dividend pay out stories since they work on target dividend pay outs. Most penny stocks do not have the cash flows for regular dividend payments.

d)  Unlike the blue chips, penny stocks have more vulnerable business models and do not have a track record to fall back upon.

Conclusion

The moral of the story is that investors can look at penny stocks with potential as likely multi-baggers. However, their business models are vulnerable so the probability of losses are quite high.