Today, the term "blue chip stocks" evokes the names of hugely successful companies that have become household names, such as General Electric (NYSE:GE) or Coca-Cola (NYSE:KO), but that was not always the case. Here's the lowdown on the 19th century roots of the expression, as well as what investors need to know about investing in blue chip stocks today.
What are blue chip stocks?
According to the New York Stock Exchange, "a blue chip stock is stock in a company with a national reputation for quality, reliability and the ability to operate profitably in good times and bad."
That's a good working definition and it has a few implications:
- Befitting a company with a "national reputation" (actually, 'international' would really be more accurate nowadays), blue chips are often megacap stocks, with a market value in excess of $100 billion. At the very least, they're large-cap stocks – no-one refers to a small-cap stock as a blue chip.
- Blue chip stocks are often associated with widely known consumer brands such as Coca-Cola, Nike (NYSE:NKE), Procter & Gamble (NYSE:PG) or Visa (NYSE:V).
- In the same vein, the "ability to operate profitably in goods times and bad" suggests that blue chips tend to be non-cyclical businesses.
What is the history behind the term "blue chip stocks"?
The only documented explanation for the origins of the term that I found comes from Dow Jones Indexes (now part of S&P Dow Jones Indices), according to which the term was coined by a Dow Jones employee named Oliver Gingold:
That term apparently got its start in 1923 or 1924 when Gingold was standing by the stock ticker at the brokerage firm that later became Merrill Lynch. Noticing several trades at $200 or $250 a share or more, he said to Lucien Hooper of W.E. Hutton & Co. that he intended to return to the office to "write about these blue chip stocks." Thus the phrase was born. It has been in use ever since, originally in reference to high-priced stocks, more commonly used today to refer to high-quality stocks.
Why "blue chip" specifically? That was borrowed from the game of poker, in which blue chips were high value chips.
However, the origins of the expression are actually much older than the event described in the Dow Jones anecdote. The earliest use I found was in an article from the New York Times dated Jun. 20, 1897:
No stock the past week, not even excepting Chicago Gas, has been so conspicuous in the trading as Sugar... Sugar has always been noted for the large amounts dealt in, equally when it was twenty-five points below par or twenty-five points above it. Whatever the price, it seemed to make no difference to the big men who specially trade in it. They swing their thousands as ordinary operators do their hundreds. Sugar has been a blue chip stock from the start.
This excerpt indicates that, at that time, the term "blue chip" was attached not to high-priced or high-quality stocks, specifically, but rather to stocks on which professional investors were betting enormous sums -- thus the obvious analogy with high value poker chips. Incidentally, the historical development of poker in the U.S. is closely linked to that of financial markets (for more on this topic, I invite you to read Aaron Brown's excellent The Poker Face of Wall Street.)
What are some blue chip stocks today?
I named four examples above, all of which are members of the Dow Jones Industrial Average. In fact, the Dow is today the quintessential blue chip index. S&P Dow Jones Indices says that "a stock typically is added [to the Dow] only if the company has an excellent reputation, demonstrates sustained growth and is of interest to a large number of investors," criteria that are highly consistent with the New York Stock Exchange's definition of blue chips. Some other prominent examples within the Dow are General Electric, Johnson & Johnson (NYSE:JNJ), JPMorgan Chase (NYSE:JPM) and 3M (NYSE:MMM).
What are the benefits of investing in blue chip stocks?
A stock only ever achieves the status of blue chip if the underlying company is among the best, most successful companies in the world – that's a good start for any investment! These are superior businesses that are highly profitable and have achieved an enviable track record of above-average earnings growth. They're the sort of stocks that billionaire investor Warren Buffett likes to invest in on behalf of Berkshire Hathaway (NYSE:BRK-B). However, if you invest in blue chips as a group, you'll likely end up earning roughly the market return -- which is nothing to sneeze at -- indeed, the Dow tracks broader market indexes quite closely.
So how does Mr. Buffett beat the market by investing in blue chips? Even the best companies have a fair price and Warren Buffett is rigorously careful about paying no more than a stock's fair value (and he has proved very capable at paying less than fair value over the years.)
Conversely, investing in blue chips will not protect you against losses or disappointing performance if you overpay for them. For example, investors who pushed up the prices of the so-called "Nifty Fifty" – a group of fifty popular large-cap growth stocks -- in the late 1960s and early 1970s were then flattened by the brutal bear market of 1973-1974. Similarly, investors who bid up the valuations of blue chip stocks to stratospheric levels in the late 1990s – Coca-Cola was trading at 48 times earnings-per-share at the end of 1999 -- suffered poor returns during the following decade.
Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool recommends 3M, Berkshire Hathaway, Coca-Cola, Johnson & Johnson, Nike, Procter & Gamble, and Visa. The Motley Fool owns shares of Berkshire Hathaway, General Electric Company, Johnson & Johnson, JPMorgan Chase, Nike, and Visa and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.