There is no strict definition of blue chip stocks, but they are generally recognized as long-standing, reliably profitable, large-cap businesses.
These are the companies that are seen as the pillars of American enterprise. They are the components of the Dow, like Walt Disney, Coca-Cola, and Johnson & Johnson.
Blue chip stocks offer a number of benefits, including safety, income, profitability, and a proven ability to bounce back from recessions and other economic shocks. Let's take a look at each one of these primary benefits.
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1. Blue chip stocks are safe
Year to date, the Dow Jones Industrial Average has outperformed the Nasdaq by an unusually wide margin, as the chart below shows.
The Dow is beating the Nasdaq by more than 20 points currently because in bear markets and uncertain economic environments, investors flock to safe stocks, like those on the Dow.
That's why so many Dow stocks have risen this year, even in a down market, and the winners are from diverse sectors, including Caterpillar, Coca-Cola, and UnitedHealth.
A rising-interest rate environment also favors blue chip stocks, as most of them tend to be highly profitable. In a high-interest rate environment, future profits become less valuable, so investors look to stocks that are generating strong cash flows in the moment.
These are precisely the types of stocks that Warren Buffett has favored, and that strategy has served him well over his investing career, especially in bear markets.
Because blue chips are able to outperform in bear markets and maintain profitability, they tend to be safer than other stocks.
2. Blue chips pay dividends
While it's not a hard-and-fast rule that blue chip stocks must pay dividends, nearly all of them do. That's because these are mature, profitable companies that have ample cash to return through dividends or share buybacks. Many of them are Dividend Aristocrats, meaning they've raised their dividends for every year for at least 25 years.
In addition, every Dow stock pays a dividend. Paying a dividend also helps make a stock more defensive, as yields will rise as the stock price goes down, making the stock more attractive to buyers.
Over the long run, dividend stocks have a history of outperforming their counterparts that don't pay dividends. This is likely because dividend stocks carry less risk, and these companies have already proven themselves in the market, as they've generated consistent cash flows for decades and have the kind of businesses that can be expected to continue bringing in cash.
3. Blue chip stocks have competitive advantages
Companies don't become blue chip stocks by luck or accident. They have proven their mettle over decades, withstanding competitors, adapting to changes in the market, and delivering consistent growth along the way.
While blue chip stocks don't tend to be high-growth companies, they use their competitive advantages to find new ways to grow. Coca-Cola, for example, has a long track record of acquiring smaller beverage brands and folding them into its distribution network to accelerate their sales. The company has also made more high-profile deals to reach into new corners of the beverage market, acquiring Costa Coffee, for example, and taking a stake in and forming a strategic partnership with Monster Beverage.
As another example, Disney benefits from a unique flywheel in entertainment where it's able to monetize its intellectual property in both box releases, TV shows, theme park rides, live entertainment, consumer products like toys, and more. It's also made several acquisitions, bringing in valuable content like Marvel and Star Wars.
Blue chip stocks have stood the test of time, and that is often because they have a competitive advantage, such as a well-known brand and an industry-leading market position. It's no accident that these companies have been a market leader for generations.
If you're looking to make investing easy on yourself, be like Warren Buffett and buy some blue chip stocks today.
