A blue chip stock can be defined as a stock issued by a nationally recognized, well-established company. Blue chip companies have long histories of being low risk investments with strong performances on the market. These companies often see little to moderate growth over time, but also have a higher price tag and (usually) lower risk.
Furthermore, most blue chip companies hold a reputation for being financially secure. They provide widely accepted household name brands. Products and services are of the highest quality for loyal consumers.
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Understanding Blue Chip Companies
Blue chips have a reputation for value and stability among the investors who rely on them. Business operations often reflect dependable earnings and available dividend payouts (though not every blue chip pays dividends). Thus, blue chip stocks are popular as they overcome economic challenges with greater ease and tend to be less vulnerable in volatile markets.
Blue chip companies often attract older, and sometimes more conservative, investors who are seeking a low-risk investment or are near retirement. Investors take a chance with blue chips for their capital preservation strategy and consistent dividend payouts. In effect, this provides investors with income support and inflation protection. Additionally, dividends help support company ownership and appease any potential legalities.
Blue chips are also great opportunities for investors who are seeking a more diversified portfolio. This is based on the company’s history of stability, good performance, minimal risks, and fair payouts. Blue chip companies are often an integral component in well-diversified, well-performing stock portfolios for these reasons.
Even if you’re not savvy in the stock market – yet! – you’re likely aware of many blue chips on the market. For example, some of the biggest names in blue chips include:
- Alphabet (GOOGL)
- Amazon (AMZN)
- Apple (APPL)
- Bank of America (BAC)
- Coca-Cola (KO)
- Disney (DIS)
- General Electric Company (GE)
- Home Depot (HD)
- McDonald’s (MCD)
- Microsoft (MSFT)
- Nike (NKE)
- PepsiCo, Inc (PEP)
- Starbucks (SBUX)
- Verizon (VZ)
- Visa (V)
- Walmart (WMT)
Characteristics of Blue Chip Companies
The blue chip stock definition recognizes that these companies have a lengthy institutional status within the economy, which means that the stocks are easier to sell whether you’re an individual or an institutional investor. Simply put, investors find confidence knowing that there will always be someone interested in these stocks. This is because blue chip status is usually only awarded to successful leaders in the market.
As a result, blue chip companies hold many common characteristics across different industries. Investors may examine a blue chip’s market cap, growth history, dividend payouts, or market index associations – or all of the above – to determine whether a particular stock is right for them.
Typically, older investors tend to focus on finding a larger investment through cash or bonds, as well as an investment that can provide capital preservation. Younger investors will usually tolerate more risk if presented with the opportunity to increase their stock portfolio percentage. Both types of investors will seek out blue chips for these reasons.
Blue chip companies have a large market value of $5 billion or more, while most hold upwards of $10 billion. These are market leaders and household names who rank within the top 3 companies in the region, as blue chips are large, well-financed corporations. However, these companies usually lack in growth due to a long history in the industry (which eventually leads to decreased opportunities for expansion, as you may imagine). This can ultimately impact the market cap.
A blue chip company has years of reliability and sustained growth with good expectations for future potential. A lengthy presence within an industry can be less attractive in comparison to faster-growing stocks for investors seeking the greatest gains. Share prices rarely make a sudden increase as there has been steady growth over time, rather than the sudden increases typical of growth stocks. At the same time, a company’s history of growth plays a big part in awarding blue chip status within the market index.
Stock Market Index
Blue chips are valuable investments with larger market caps, and as such, they often dominate large-cap index funds. Index funds track an index within a specific section of the stock market. It helps identify the market industry and economic performance. The major market indexes are:
- Dow Jones Industrial Average (United States)
- Nasdaq-100 (United States)
- Standard & Poor (S&P) 500 (United States)
- TSX-60 (Canada)
- FTSE (United Kingdom)
Investors who turn to low-cost index funds or ETFs – funds that contain a carefully crafted selection of investments – may gravitate toward funds that track all or part of these indexes in particular, as they often have high potential for consistent gains. This is one way that investors can ease their transition into investing and diversifying their portfolios.
Most blue chip companies offer substantial, steady dividend payouts to shareholders. This is more typical for mature companies that are less focused on growth, which means not every company offers a dividend. Newer and younger companies will need continuous funding to maintain business growth and development, which makes them amongst the least likely to pay their shareholders. On the other hand, a company that has a free cash flow will allocate profits to stockholders as dividend payments. A growing market will draw in more profit and result in dividend increases as well.
Safety of Blue Chip Companies
Blue chips hold a reputation for surviving some of the worst market challenges and stock cycles. Remember: the definition of a blue chip stock holds that these companies tend to be safer investments with a steady history of riding out stock market fluctuations. However, this does not mean all blue chip companies come out profitable on the other side.
Some notable examples of bankruptcy from the 2008 global recession include the Lehman Brothers, General Motors, and many European banks like the Northern Rock. Other examples of blue chip downfalls in the United States are Enron, Washington Mutual, and Chrysler.
Why Blue Chips Matter for Investment
Blue chips have a certain popularity amongst investors who are reluctant to take risks. These investors are often interested in creating larger and more diversified portfolios. Being able to recognize investment opportunities and potential risks is important when researching blue chips to find the best fit.
Investment Benefits of Blue Chip Companies
Dividend payments from blue chip companies can be reliable income sources for investors. These financially stable businesses maintain steady earnings without needing to invest in company growth and can place funding elsewhere. This can also lessen the risk of investment for some investors – even if the company isn’t a blue chip.
Still, having low volatility allows for blue chips to enjoy a steady stream of revenue from multiple different avenues. This strategy takes into account an investor’s personal risk tolerance, investment horizon, and financial goals.
The dependability and transparency of blue chip companies expresses their long history and status as top leaders within an industry. They have maintained stable operations utilizing a seasoned team and keeping an open honesty with consumers.
Drawbacks of Blue Chips
Some important drawbacks that investors will take into account the company’s growth, price per share, and economic history. This helps determine the blue chip’s market value and any potential risks.
As previously stated, blue chips will grow steadily compared to trade-off companies. This lessens the potential of any economic risks in the long run. However, blue chips hold a large-cap market value where single shares cost hundreds of dollars or more, and as a result, younger investors may be less interested. It’s also important to recognize that even though a company is strong, it is not invulnerable to downturns (back to you, Enron).
Blue Chips and Fixed Income Securities
Fixed income securities function similarly to long-term loans by lending money to the government, a bank or a corporation. Regular payments will then occur to the lender until the loan reaches maturity. Examples of this type of security include savings bonds, certificates of deposit, and mortgage-backed securities. This acts as an additional layer of protection from any future price fluctuations or principal investments.
A Final Word on Blue Chips
So, what is a blue chip stock?
There are many factors that make up a blue chip stock, from their history to their market cap, many of which attract investors to these stocks. The financial security of these larger, well-known businesses often interest investors who want stability and steady payouts. Additionally, blue chips are generally capable of weathering market challenges, which means these stocks have the potential to come out on the other side unscathed. (At least eventually).
Older investors tend to be risk-averse and avoid instability where possible. Thus, this group seeks income security and inflation protection in blue chip investments. Most of the time, blue chips don’t expose investors to sudden, drastic downfalls, which provides a greater opportunity for consistent income.
On the other hand, younger investors with less experience and more time to make mistakes may go for bigger growth and riskier chances. This group may avoid blue chips due to the lack of excitement, as well as the higher share prices that may be prohibitive to younger individuals.
Fun Facts About Blue Chips
Oliver Gingold was a Dow Jones employee in 1923. Gingold proposed the term ‘blue chips’ as representing the higher-priced stocks trading at $200 or more per share. However, this is not necessarily true for today’s value. Companies of today are well-seasoned and offer only the highest-quality products and services.
The term ‘blue chips’ is said to have been copied from poker as the blue chips represent the highest value in the game. The blue chip stock definition of today is not too far off!
Blue chips are purchased due to their lower risks and stabile finances to give investors consistent returns.