Would you accept zero capital growth for the next five years?

After years as a successful investment strategy, something has happened to blue chips over the last 5 years. Despite huge gains from global markets, Australia’s biggest companies have experienced zero capital growth since 2013.

In this wire, we discuss why Australia’s favourite companies have ceased generating positive returns, whether we can expect them to improve in the future, and where we might look to find the Blue Chips of tomorrow.

If you own the Big 4 Banks, BHP, RIO, Woolworths, Wesfarmers, or Telstra, this article will provide you with an essential re-evaluation of their prospects.

Singing the Blue-Chip Blues

After years as a successful strategy, many investors are currently wondering “what happened to my blue-chip investment strategy?”

Companies like Commonwealth Bank, BHP, Woolworths, and Telstra are all favourite ideas for investors. They form the bedrock of most self-managed super funds (SMSF’s) and have generated exceptional results over the decades.

But something seems to have changed in the last few years; our blue-chip companies are not generating the returns we have become accustomed to.

Australian Blue Chips have performed poorly since 2013.

The truth is that investing in large, mature companies – sometimes referred to as “Blue Chips”– has never been a successful long-term strategy.

It’s a misconception born out of something called “success bias”.

When looking back, all we see are the companies that have survived. Those companies tend to have gone through a protracted period of growth and flourished. What we don’t see (and tend not to think about) are all the companies purchased over the years that failed.

For instance, when blue-chip investors thought about investing in the 1980’s they would have considered buying companies like Ansett. At the time BHP was considered a punting stock.

In the 1990’s HIH insurance might have looked like a golden idea, while Westpac would have looked like a company on the brink after almost collapsing in 1992.

The success that investors have seen when investing in today’s blue chip companies was driven by their past growth, not their current maturity.

Once a company has matured, it’s very difficult to identify where its future profit growth will come from.

How do the growth profiles of today’s blue chips stack up?

A quick look at the price performance of some of Australia’s favourite companies provides for some interesting consideration:

Commonwealth Bank saw tremendous earnings growth, thanks to over 25 years of uninterrupted economic growth, coupled with an eagerness to lend more to residential property investors.

But where to from here?

With lending standards now tightening, the property market saturated, and legislation capping Loan-to-value ratios (LVRs), where can CBA capture the next leg of growth?

We aren’t sure. But our concern is that the company is now mature. At best, CBA is likely to become a dividend stock, hopefully generating a return of circa 6% p.a.

The key risk is that the company seeks to find growth from a new area of business. That may work, but our experience has been that it is difficult to migrate to a business outside of one’s core competencies.

Commonwealth Bank share price

BHP is possibly the most loved of Australian companies. The company has seen its share price rise by 100 x since the 1980s. However, the question isn’t “what has it done?”, but rather “what is it likely to do going forward?”

BHP Billiton

BHP is a well-run company and from the 80s through the 90s, the company continued to manage its business well. But in the 2000s, the game changed. China’s massive demand for raw material saw BHP in the prime position to deliver on those demands, and the share price rocketed from $5 per share to $45 per share in just 10 years. However, with Chinese demand now assumed, and incorporated into the share price, where does the next leg of growth come from?

It’s not just CBA and BHP that look post-growth, it’s most of the ASX top 20.

Investing in Blue Chips is not a safe bet.

Despite common consensus, investing in Blue-Chips is not a safe bet.

As any long-term Telstra investor can attest, when a company becomes mature, the sector evolves, and competition increases the risks to an investor’s capital becomes real.

20 years of pain from Telstra

In fact, the majority of the Top 20 Australian companies appear to be post-growth.

5 years from the S&P/ASX20

What can we do about it?

As far as we can tell there are two options:

1. Do nothing. Be satisfied with little or no capital growth, and a dividend yield.

2. Recognise that secular, long term performance comes from growth, and blue-chip shares may not be the place to find it.

In recognising that performance comes from growth, one can understand why the US markets have reached new highs since the GFC and the Australian market continues to struggle.

While our index is made up of mature industries, the US is driven by technological growth – Apple, Google, and Amazon.

Recognising this issue is the first step to saving your portfolio.

We don’t have all the answers for Australian investors, but there is a plethora of high quality businesses with growth tailwinds that are likely to become the blue chips of tomorrow. Of course, in order to find these key prospects, you need to have the time to discover and identify them.

The challenge for investors is to recognise that there has been a structural change for the biggest Aussie companies over the last five to ten years, and to take action that reflects those changes.

Renewed strategies are now necessary to identify tomorrow's blue chips and avoid disappointing investment results.