For many of us blue chip companies are the top 50 big companies. But I don’t agree with this. Qualification to become a blue chip company is not to have a huge market capitalisation and massive infrastructure surrounded all over the country and world.

My definition of Blue Chip Company is to have excellent Financial stand with capacity to generate consistent great profits and giving great Return on Equity to its shareholder.

That should be the characteristics of Blue Chip Company rather than the NSE Nifty large 50 companies. Look at your portfolio and think are you really invested in Blue Chips?

With that vision keeping in mind our biggest task is to invest in only those companies that pass our Blue Chip definition. The very first step we do is run all the financial data of all the listed companies with our metrics and rate them (A1, A2, B1, B2 and C). We call this rating as VQR (Valueoperations Quality Ratings). This process is not subjective in nature. That means no human emotions are involved while rating them. Its objective in nature, we just run the metrics and get the result.

The very best A1 quality has lowest probability of having unpleasant circumstances. But that doesn’t mean that prices can’t fall down of this company. But again the chances of survival are better.

The second step is to calculate the Intrinsic value of the company. While calculating the intrinsic value we take the holistic approach of the business and consider the essentials like what dividends company is paying back to its shareholder, EPS, Equity per Share etc rather then calculating its through PE ratio’s or any other techniques.

In regards to Intrinsic value there are few warnings attached to it. First, Intrinsic value of any company can change. When company announces economic environment is worse or downgrades its profits and sales figure etc. even a rise in interest rate could affect the intrinsic value of any business as value declines. Well that’s business!!

Second, I don’t have any special power to forecast price of any stock. The prices of any stock can fall down even though value is unchanged. This is because in short term prices behave independently but in long term they always follow the fundamentals and intrinsic value of the business.

I hope that answers a lot of questions arising how Valueoperations work! We are exited to launch our services for those A1 list of companies very soon!! The only way to access them would be to register on our website (As far as my knowledge goes, but don’t take this as my words on behalf of Valueoperations).

The other question many people ask me is why do you give so much importance to ROE (Return on Equity). Examples are the best way to make people understand, so here is my try to explain why always stick to A1 companies, as they are the real Blue Chip Companies and why ROE is so much of importance.

Imagine you are back 5 years and have INR 100,000 to invest in equity. You are looking at JP Associates and Ester Industries and planning to invest with one of them.

A snippet of JP Associates in March 2007 is as follows:

Total Equity of Share holders

INR 2,872.95 Crore

Total Debt on the company

INR 5,431.06 Crore

Net profit of the company

INR 414.90 Crore

Earnings Per Share (EPS)

INR 18.92

Return on Equity

19%

Net operating Cash Flow

INR 808.05 Crore

Net cash used in investing

INR 2,108.39 Crore

Net cash from Financing

INR 1,060.35 Crore

The closing price of JP Associate on 8th July 2007 was INR 546.10. So if you had invested your INR 100,000 in this company then you would have bought 183 Shares.

Corporate Action taken by this company in last 5 years are as follows:

26th Dec 2007 split in share INR 10 now new INR 2/ share

183 *5 = 915shares

28th Jan 2008 – Interim Dividend paid/share

INR 0.20

21 Aug 2008 Final dividend paid / share

INR 0.30

31st Oct 2008 – 1st Interim Dividend

INR 0.20

8th May 2009 – 2nd Interim dividend

INR 0.20

24th Sept 2009 – Final Dividend

INR 0.30

30th Oct 2009 – Interim dividend

INR 0.36

18th Dec 2009 – Bonus 1:2

915 + 610 = 1,525 Shares

17th Sept 2010 – Dividend

INR 0.54

9th Feb 2011 – Dividend

INR 0.40

If I add those entire dividend paid into current value of share then your INR 100,000 would have changed to INR 128,139.65.

Amazing figure!! Isn’t it? Well the ROE of JP Associates was good in 2007 (19%) but then it deteriorated in the following years as 4% in 2008, 23% in 2009, 15% in 2010 and 14% in 2011. the average is coming of 15% in last 5-years. Which is amazing and you would debate as a great return. Again to remind you all that I am not saying JP Associate is bad company but it is not mine A1 rating company.

Lets flip the coin and talk about the other company that is Ester Industries.

The closing price of Ester Industries on 8th July 2007 was INR 9.74. So your INR 100,000 would have fetched you 10,266 shares of the company.

A snippet of Ester Industries in March 2007 was as follows:

Total Equity of Share holders

INR106.39 Crore

Total Debt on the company

INR 103.68 Crore

Net profit of the company

INR –13.97 Crore

Earnings Per Share (EPS)

INR –2.52

Return on Equity

-13%

Net operating Cash Flow

INR 5.60 Crore

Net cash used in investing

INR 16.95 Crore

Net cash from Financing

INR 12.15 Crore

It is important to understand that Ester Industries was not in our A1 rating as of 31st March 2007 report. But soon after 1st quarter of 2007 –08 results we noticed the change in quality rating of this company. The first quarter of 2007 –08 was the second profitable quarter for the company and companies financial stand started looking strong as the company started generating profits.

Corporate actions taken by Ester Industries in last 5 years as follows:

22nd Aug 2008 – Dividend

INR 0.50

12th June 2009 – Dividend

INR 0.50

15th July 2010 – Dividend

INR 1

11th Nov 2010 – Dividend

INR 2

Again if I add entire dividends into current market price on 7th July 2011, your INR 100,000 might have changed into INR 548,204.40.

Well the ROE for Ester industries for last 5 years were as follows:

In 2007 it was –13%, 2008 it was 10%, 2009 it was 32%, 2010 it was 18% and in 2011 it was 75%. Overall the average for 5 years was 24%.

This entire example was to make you understand the importance of what impact it would have made to your portfolio if you don’t invest in real Blue chip companies. It is very important to invest in company whose intrinsic value is growing and always buy at discount to its intrinsic value.