To an investing newbie, the term blue chip might just sound like a fancy vehicle for your salsa. But blue chips, more specifically blue-chip stocks, are a part of many people’s diversified portfolio offerings.
So, stave off that craving for a chip and take a moment to understand the importance of these specially designated stocks, and how they might feed into an investor’s larger investment strategy.
Related: What is considered a good return on investment?
What are Blue-Chip Stocks?
If you look up blue-chip stocks in the dictionary, you won’t find a list, chiseled in stone, that says which stocks are and forever will be designated blue chip. It could be considered more of an art than a science.
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When people refer to blue-chip stocks, they’re not adhering to a formal set of definitions or the decision of a formal body or committee. That can make things a little tricky, but because of the many traits blue-chip stocks share, they’re easy to spot.
Common traits of a Blue-Chip Stock
No two blue-chip stocks are built exactly the same, but there are some similarities among this class of investment. Typically, a blue-chip stock:
• Is a household name. From the grocery aisle to television brands, chances are this stock is a familiar name outside of the stock market. Companies like Disney, Coca-Cola and IBM are all considered blue-chip stocks.
• Is an industry leader. The stock has earned its blue-chip reputation by innovating and being a leader. For that reason, an investor can expect the company to be a leader in its industry.
• Has a market capitalization of $5 billion. This isn’t a hard and fast rule, but a blue-chip stock’s market cap, or the value of all its shares of stock added together, is generally expected to be worth $5 billion at least.
• Is well established. Blue-chip stocks have a history of financial security, which means they need to have been on the market for some time before gaining their designation. A company that’s just gone public is not likely to be deemed a blue-chip stock.
• Has a model that performs well, and even grows, regardless of the market. Blue-chip stocks are reliable, which means they typically perform the same regardless of the economic climate.
• Is listed on an index. You’ll find blue-chip stocks listed on the Dow Jones Industrial Average, S&P 500 Dividend Aristocrats, or the Bridgeway Blue Chip 35 Index.
• Is paying out dividends. Blue-chip stocks typically pay out dividends, or a share of the company’s profits, to shareholders, aka investors. That means an income stream on a quarterly basis.
There’s no consensus on what exactly defines the best blue-chip stock, but many blue-chip stocks share the above traits.
History of Blue-Chip Stocks
Lore has it that the term blue chip stock originated in the 1920s. An employee of what would come to be known as Dow Jones noticed a company’s stock being sold at $200 a share (close to $2,600 today, adjusted for inflation).
He declared he’d have to go write about these “blue-chip stocks” because of their high price.
Most believe that the term blue-chip stock is in reference to the game of poker. Traditionally in a poker game, the blue chips have the highest value.
But, to extend the poker metaphor any further on blue chips could be misleading —typically, they’re not seen as the biggest gamble in the stock market. While they were once known as the most expensive stocks, nowadays they’re considered some of the most reliable.
Historically high dividend Blue-Chip Stocks
Companies that are considered blue-chip stocks might be easy to identify. Here are a few that have been historically considered blue-chip:
• General Electric
• Eli Lilly and Company
• Kellogg Company (commonly known as Kellogg’s)
• Procter & Gamble
• HJ Heinz (currently The Kraft Heinz Company)
• DuPont (currently DuPont de Nemours, Inc.)
• General Mills
• IBM (International Business Machines)
• UPS (United Parcel Service)
These companies have been around for decades (some even longer), and because of their history of returns and consistent performance, they’re all considered blue-chip stocks today.
Modern-day Blue-Chip Stocks
While those on the list above are still widely considered to be blue-chip stocks, a few newcomers (or relatively new) have crashed the party. Today, the following might be referred to as blue-chip stocks as well:
• Microsoft Corporation
• Berkshire Hathaway Inc
• Johnson & Johnson
• JPMorgan Chase & Co
You’ll notice that some of the above haven’t been around for very long and aren’t on the Dow (we’re looking at you, Alphabet), but as always, there will be exceptions to the rule.
And while these newbies are rising stars in the stock market, the designation of blue-chip stock isn’t permanent. As it’s not an official title, companies can be stripped of it when they stop meeting the criteria.
It’s always good to remember, even with the historically well-performing stocks, there’s no such thing as a sure thing in the investment world.
What’s considered a blue-chip stock by one index or investor might not be by another. While there are some standard measurements, there’s no ruling body deciding on who gets blue-chip status.
Advantages (and disadvantages) of investing in Blue-Chip Stocks
Like any investment strategy, blue-chip stocks have their benefits and drawbacks. Before investing in blue-chip stocks, an investor may want to consider weighing the positives and negatives of these types of stocks on their overall investment strategy.
Blue-chip stocks have their fair share of benefits:
They’re established. Blue-chip stocks have been around long enough and are included in some of the most well-known stock indexes. Some of these indexes can have stringent rules that only the most financially stable companies could meet.
In addition, they’ve been around long enough to prove their ability to do business. They’re potentially leaders in their field and may be at the peak of their industry.
They’re big. The size of these companies is often global, meaning they’ve got economies of scale on their side. They have the potential to grow faster, secure larger loans and continue to be a competitor in the market. Due to the size of their resources, blue-chip stocks can often appear to be more stable than smaller companies in their field.
They consistently return dividends. Blue-chip stocks are considered low risk with respect to other stocks because of their size and history in the market. Many of them also have a proven track record of yielding dividends consistently. Some consider them to be a safe bet relative to other stocks, due to their consistent, but not necessarily massive, returns.
They’re easy to follow. The companies behind many blue-chip stocks tend to be well known. They do big business, which means announcements and news around them is likely to make the front page of the financial section.
There’s no need to dig around to see what these companies are up to. For those just beginning to invest, blue-chip stocks can be reassuring since they’re already familiar and part of the news cycle.
There’s no such thing as a “sure thing” and the drawbacks of blue-chip stocks prove this point. Here are a few disadvantages to keep in mind while considering an investment strategy.
They fall a lot harder. The old adage “the bigger they are, the harder they fall” is easily applicable here. Just because a blue-chip stock has a solid history does not ensure a profitable future.
With all eyes on these big companies, bad news can travel fast and lead to drops in the sales price. Any company can fail, even the ones behind the blue-chip status.
Limited growth. Blue-chip stocks are considered consistent and stable — some might say low risk. And, typically, with low risk comes stable return. Blue-chip stocks set the standard, or average, for the market, so it’s nearly impossible for them to beat it.
For example, compare UPS to a small shipping upstart. UPS is widely used, which makes it consistent, and may not have much room to grow. In contrast, an enterprising shipping company managed well could possibly double in size year after year. It’s much less likely that a blue-chip company will innovate and grow at the same scale as a smaller corporation.
Less cutting edge. Blue-chip stocks are like heritage brands. Kellogg’s brand cereal might be an everyday breakfast staple, but chances are it’s not at the cutting edge of technology or innovation. For that reason, some investors might find it a little boring to invest in blue-chip stocks.
More dividend focused. Blue-chip stocks might often be the stock of choice for investors focusing on a low-risk portfolio due to their consistent performance and returns. However, if an investor’s tolerance for risk is a little higher, they might be willing to take more risk for a higher return.
They may be expensive. Blue-chip stocks tend to be well-known brands and often a highly desirable part of people’s investment strategies. For that reason, it’s unlikely to get a deal on them.
Including Blue-Chip Stocks in a portfolio
Here’s the thing — like a well-balanced meal, investing in blue-chip stocks can be one part of a healthy investment strategy. For those looking to make blue-chip stocks a part of their balanced investment diet, here are a few ways to invest in them.
If one blue-chip stock, in particular, strikes an investor’s fancy, they can go right ahead and purchase it directly.
If the price per share is too steep for an investor’s budget, they might want to consider fractional share investing.
Choosing to invest in an individual stock might be a good way to get a feel for the market, or it might be a way to take a more active investment strategy. Either way, a brokerage can handle an investor’s single blue-chip stock purchase.
Index funds and ETFs
Alternatively, if no individual stock strikes an investor’s fancy, but they still want to get into the blue-chip game, they might consider investing in index funds or ETFs.
Index funds and ETFs do the stock picking for the investor who wants to choose an index fund or ETF that deals in blue-chip stock. Both index funds and ETFs are sometimes considered a more passive form of investing, meaning investors don’t need to pick every individual stock they want to invest in. Think of it as buying a variety pack instead of a single flavor.
Investing in a blue-chip fund or an ETF is investing in a portfolio of companies that a broker has vetted and designated as blue-chip by their standards.
Ready to invest in Blue-Chip Stocks?
Brokerages give stocks the blue-chip designation when they have a strong performance history, consistent returns and a proven market capitalization.
For beginning investors, blue-chip stocks can be a reassuring, familiar company to invest in. For that reason, blue-chip stocks are often perceived as a safe investment.
Safety in an investment strategy is important, but it’s like a balanced diet. It’s not recommended to eat the same thing day after day, just like it’s not recommended for an investment strategy to be made of a single component.
Diversification is typically an important thing to consider, no matter how you designate your investments.
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
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