Blue-Chip Stocks

For individual investors seeking quality and stability in equities, blue-chip stocks are a popular solution. Blue chips have a mythological status for investors. Part of that mythos is that there is actually no single definition of a blue-chip stock.

The “blue chip” name is derived from poker, wherein the blue colored chip was traditionally the highest-value token in a simple set of poker chips. Generally, blue-chip stocks are considered high-quality investments—companies that can provide more stable returns in times of both economic growth and retreat. They tend to be large-cap stocks, dominant in their industry, with decades of dependable growth. Large-cap status denotes that blue chips are worth billions of dollars at a minimum in market capitalization, which is determined by multiplying outstanding shares by share price.

Because of their characteristics, blue-chip stocks are also normally components of U.S. stock indexes, such as the S&P 500 index and the Dow Jones industrial average. The latter is noted for its selection of 30 companies that are titans of their respective industries; a quick look at that list of stocks would provide you with a sense of current blue chips. Components of the Dow include IBM Corp. (IBM), Apple Inc. (AAPL), McDonald’s Corp. (MCD), Walt Disney Co. (DIS), JPMorgan Chase & Co. (JPM) and Walmart Inc. (WMT).

Only a small percentage of the stocks traded on U.S. stock exchanges meet enough characteristics to be considered blue chips.

Should You Invest in Blue-Chip Stocks?

Blue-chip stocks are popularly considered to be low-risk stock investments. Investors that champion blue chips tend to be older and have a shorter investment horizon to reach. Many blue chips also pay a dividend, and many retirees look for income solutions from their investments.

Returning value to shareholders is an important characteristic of blue-chip stocks when it comes to deciding whether you want to invest in them or not. As lower-risk, large-cap growth stocks, blue chips may not provide as much in the way of capital gains over a short period. This is an issue if you are a younger investor with more than five years to realize investment returns from your portfolio. In fact, if you break out the performance of stocks by small-, mid- and large-cap categories over a 100-year period, it is small-cap stocks that generate the most returns, though with greater short-term volatility.

As dominant companies, blue chips face few competitors; they have wide moats that create barriers of entry for new competition. With diverse but well-known products and services, blue chips are familiar to consumers as well as investors, helping them maintain their status.

Their status also means that there is a high level of attention paid to blue chips’ financials by analysts and investors. This creates an abundance of research that, paired with their market salience, makes it hard to purchase shares of blue chips at a bargain. However, this does not mean that value investors cannot buy blue chips or that blue chips never meet value-investing criteria.

Because blue-chip companies tend to be mature, management often focuses on returning value to shareholders through dividends and share buybacks. Being shareholder-friendly also entails managing earnings growth to meet Wall Street’s expectations. Companies that miss earnings expectations are often punished by investors for the immediate quarter and subsequent quarters; hitting or missing expectations has a notable effect on stocks that can lead to overperformance or underperformance, respectively, for subsequent quarters.

If you want to invest in blue chips, you can do so by owning individual stocks or through funds. You can buy stocks or funds through a broker.

Passively managed exchange-traded funds (ETFs) will give you a diverse investment in most blue chips through tracking an index; there are also actively managed mutual funds that focus on blue chips, such as the Fidelity Blue Chip Growth fund (FBGRX).

If you want to select individual blue-chip stocks, do so with a specific strategy. Blue chips represent diverse industries and do not all feature the same general “blue chip” characteristics. While income generation is often a feature, not all blue chips pay a dividend. Blue chips are generally considered lower-risk, but investing in one blue-chip stock or a small set of blue-chip stocks does not guarantee safety from downside risk. Over time, companies gain and lose blue-chip status. Consider General Electric Co. (GE) or Kodak.

Conclusion

Individual investors seek blue-chip stocks for their quality and stability. Blue chips are dominant companies within their industry, with decades of reliable earnings growth and few competitors to match them—only a small percentage of all U.S. exchange-listed stocks have blue-chip status.

Blue chips are attractive investments for investors with shorter-term goals, and they tend to return shareholder value in the form of dividends (if you are looking for income) and share buybacks. However, if you have an investment horizon of five years or more, other stocks may offer better long-term returns.

You can invest in blue chips through individual stocks, or through mutual funds and ETFs, purchased through your broker.