What are Blue Chip Stocks?
Blue chip stocks are stocks issued by large market capitalization firms, which are leaders in their industries, release strong operating and financial results and consistently deliver dividend payments to their shareholders.
A blue chip is stock in a corporation with a national reputation for quality, reliability, and the ability to operate profitably in good and bad times.
A blue-chip stock is a huge company with an excellent reputation. These are typically large, well-established and financially sound companies that have operated for many years and that have dependable earnings, often paying dividends to investors. A blue-chip stock typically has a market capitalization in the billions, is generally the market leader or among the top three companies in its sector, and is more often than not a household name. For all of these reasons, blue-chip stocks are among the most popular to buy among investors. Some examples of blue-chip stocks are IBM Corp., Coca-Cola Co. and Boeing Co.
The Story behind the term “Blue Chip Stocks”
This famous term echoing through Wall Street even today comes from an employee named “Oliver Gingold” of a famous company “Dow Jones”.
The term got a push in between 1923-24. Gingold noticed that many shares were trading at $200 to $250 or more as he was standing by the stock ticker of a brokerage firm.
He returned to his office after noticing these high trading prices to write about “Blue chip stocks”. He related all the high priced stocks with the blue chips which are of the highest value in the game of poker.
Originally, this connotation was only related to high priced stocks but then later as time passed by, this term was broadly defined as high-quality stocks.
What Makes a Stock a Blue Chip?
Think of a blue-chip stock as a stock you would bring home to meet your parents: It makes a good impression and has the substance to back it up. It’s stable, responsible and reliable.
Blue-chip companies have proven themselves in good times and bad, and the stocks have a history of solid performance. Stocks that are considered blue-chip stocks generally have these things in common:
- Large market capitalization. Market cap is a measure of the size and value of a company. Blue-chip stocks are often large-cap stocks, which typically means they have a market valuation of $10 billion or more.
- Growth history. Blue-chips have a reliable, solid history of sustained growth and good future prospects. They might not be flashy like fast-growing tech stocks, but that’s because they’re already established.
- Component of a market index. Blue-chip stocks are in major market indexes like the S&P 500, the Dow Jones Industrial Average and/or the Nasdaq 100.
- Dividends. Not all blue-chip stocks pay dividends, but many do. Dividends are regular payments made to investors from a company’s revenue. Companies that pay dividends are often mature, which means they may no longer need to invest as much revenue back into their growth.
Blue Chips as Part of a Larger Portfolio
While blue-chip stocks are appropriate for use as core holdings within a larger portfolio, they generally shouldn’t be the entire portfolio. A diversified portfolio usually contains some allocation to bonds and cash. Within a portfolio’s allocation to stocks, an investor should consider owning mid-caps and small-caps as well. Younger investors can generally tolerate the risk that comes from having a greater percentage of their portfolios in stocks, including blue chips, while older investors may choose to focus more on capital preservation through larger investments in bonds and cash.
Benefits of Blue-Chip Stocks
Investors find a number of benefits in buying shares of blue-chip companies. These include:
- Low volatility: As big corporations, blue-chip companies benefit from economies of scale and also enjoy revenue streams from multiple products and services. While not immune from economic downturns, well-established blue chips are not easily shaken, even in times of market volatility.
- Dependability and transparency: With their long histories and status as industry leaders, blue chips operate with seasoned management teams. The companies’ fame and high profiles tend to keep their operations transparent.
- Rich income: Steady earnings without a need to invest heavily in growth means blue chips can provide steady, strong dividend payments. Next to US Treasuries, blue-chip dividends are the most reliable go-to for income-oriented investors.
Drawbacks of Blue-Chip Stocks
On the flip side, the blue-chip features that work as benefits for some investors act as deterrents for others.
- Low growth: Unless you invested in one decades ago, you won’t make a killing in blue-chip stocks. These are mature companies, for the most part — their big-growth days are behind them. They appreciate steadily, but not dramatically. That’s the trade-off for their low risk.
- Expensive: No bargains here — blue-chip stocks have been discovered. Because blue chips play in the large-market cap sandbox, the price to buy in on a single share often runs a couple hundred dollars or more. For many younger investors, the share cost far exceeds the level needed to acquire a stock position of any significant size.
- Strong but not invulnerable: Sometimes a sterling reputation can hide the fact that a blue chip is resting on its laurels and failing to innovate. Monolithic corporations can be slow to respond to changing times, consumer demands, and industry trends. Though it happens rarely, blue chips can and do go bankrupt: General Motors and Lehman Brothers are two recent examples.
Examples of Blue-Chip Stocks
There is not a formal list of blue-chip stocks but, typically, the components represented in a well-known index will be considered as such and are referred to as blue-chip indices – this includes global indices such as the Dow Jones, the DAX, CAC 40 and Euro Stoxx 50. Indices like the FTSE 100 and S&P 500 contain a mix of blue-chip stocks and large- or mid-cap companies that aren’t considered blue chip.
Blue-chip stocks are subject to change, but some common examples include:
- 3M (MMM)
- Alphabet (GOOGL)
- Amazon (AMZN)
- American Express (AXP)
- Apple (AAPL)
- Bank of America (BAC)
- Coca-Cola (KO)
- Costco (COST)
- Disney (DIS)
- Goldman Sachs (GS)
- Home Depot (HD)
- IBM (IBM)
- Johnson & Johnson (JNJ)
- McDonald’s (MCD)
- Microsoft (MSFT)
- Nike (NKE)
- Starbucks (SBUX)
- Verizon (VZ)
- Visa (V)
- Walmart (WMT)