4 days ago
What's the best way to identify a blue-chip stock?
New investors are often told to avoid risky stocks and to gravitate instead to large blue-chip companies with profitable businesses.
The problem is, there are no hard and fast rules when it comes to defining what a blue-chip stock is – and what it is not. But research into quality factors can help to shed a little light on the situation.
Profitability has become a successful measure of quality in recent years and it was highlighted by Professor Robert Novy-Marx in a paper called The Other Side of Value: The Gross Profitability Premium. More specifically, he studied the impact of the gross-profits-to-assets ratio (GP/A) in the United States and showed that it performed well.
The ratio is calculated by dividing a company's gross profits by assets. For today's purposes, the numerator uses gross profits (revenues minus cost of goods sold) over the past four quarters while the denominator is equal to total assets from the most recent quarter.
Norman Rothery: Canadian portfolios to consider
It's useful to start looking for blue-chip stocks by focusing on large companies before refining the list using profitability. That's why today's search begins with the largest 100 stocks on the Toronto Stock Exchange (TSX) by market capitalization. A tracking portfolio that follows the largest 100 stocks gained an average of 9.3 per cent annually over the 25 years to the end of April, 2025. In comparison, the S&P/TSX Composite index gained an average of 6.8 per cent annually over the same period. (The returns herein are based on back-tests using monthly data from Bloomberg. They include dividend reinvestment but not fund fees, taxes, commissions or other trading costs. The portfolios are equally weighted and rebalanced monthly.)
Unfortunately, gross profits aren't available for financial stocks such as banks and insurance companies, which represent a significant chunk of the Canadian stock market. Currently, 25 of the largest 100 stocks on the TSX are financials, while the other 75 are non-financials. A portfolio composed of the latter gained an average of 9.7 per cent annually over the 25 years to the end of April, 2025. Removing the financials improved returns slightly over the period.
The profitability portfolio buys the 20 per cent of stocks with the highest GP/A ratios from the non-financial names in the largest 100 stocks on the TSX. The portfolio produced average annual gains of 11.6 per cent over the 25 years to the end of April, 2025. That is, buying large stocks with high GP/A ratios provided a nice return boost over the period.
Mind you, the results come with a technical caveat because the back-tester's GP/A data was a little sparse in the early years. The profitability portfolio currently contains 15 stocks (thanks to the exclusion of financials) and held a similar number, with small variations, back into 2010. But it held just nine when the back-test started in 2000 because some non-financial stocks lacked sufficient data early on.
That said, the profitability portfolio performed well in recent years when the data was fulsome. It beat the market index by an average of 5.7 percentage points annually over the 15 years to the end of April, 2025, which is nearly a percentage point better that its average annual outperformance over the full 25 years.
The profitability portfolio's stocks tend to trade at higher multiples, and are more growth-oriented, than most of the other portfolios I follow for The Globe. It currently holds 15 stocks and, as a group, they have a median (half are higher and half are lower) earnings growth rate of 16 per cent over the past four quarters and a median total return of 34 per cent over the past 12 months. The portfolio's stocks trade at a median price-to-earnings ratio (P/E) of 33 and a median forward P/E of 23 based on analyst earnings expectations for the next four quarters. Income investors will likely be disappointed by the portfolio's modest median dividend yield of 1.1 per cent.
While it might not represent the final destination, the profitability portfolio offers an interesting starting point for investors seeking Canadian blue-chip stocks. I hope to explore the approach more fully this summer during my tour of different quality measures.
You can examine the stocks in the profitability portfolio, and other I follow for The Globe and Mail, via this link.
Norman Rothery, PhD, CFA, is the founder of
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