Imagine that you've been hired as general manager of an expansion baseball team in a deserving city such as Las Vegas or Buffalo, N.Y. If you could select any player in the entire league, who would you choose? Would you be looking for obscure utility infielders who walk a lot or the dominant performers in the game -- players such as David Ortiz, Albert Pujols, and Mariano Rivera?
Ask yourself the same question about stocks. If you are looking to provide ballast for your portfolio by establishing one or two core positions, what would you choose: a risky small cap that just went public or an industry stalwart that has outperformed the market over the past 25 years?
Every portfolio should be anchored by a few reliable, established, well-run businesses that pay dividends and let shareholders sleep easy -- that is, every portfolio should have blue chips.
I know one when I see one
Rather than bore you to tears with a textbook definition of the term "blue chip," let's just agree that most of us know a blue-chip stock when we see one. For me, a blue chip sports a high price tag, carries little risk, boasts a distinguished history of successful operations, and usually pays a decent-sized dividend. According to this view, Colgate-Palmolive (NYSE:CL), with a price-to-earnings ratio (P/E) of more than 26, a low beta (a measure of a stock's volatility in relation to the market), a track record dating back to the 19th century, and a dividend yield of more than 2%, is clearly a blue chip. A risky, dividend-free, unproven company such as Taser (NASDAQ:TASR), on the other hand, is not.
Identifying blue-chip stocks is easy enough. The real question is: Can you make money investing in these companies? The financial "experts" would argue that you can't. But Hall of Fame investors Warren Buffett and Peter Lynch have proved that you can. I tend to agree with them.
A look at some of the top blue chips in America over the past 10 years illustrates the type of returns you can achieve by investing in large, stable companies:
10-year returns of selected blue chips
|
Company |
Ticker |
Investment in 1996 |
Investment in 2006 |
Total Return |
|---|---|---|---|---|
|
Wells Fargo |
(NYSE:WFC) |
$10,000 |
$46,649 |
367% |
|
ConocoPhillips |
(NYSE:COP) |
$10,000 |
$36,300 |
263% |
|
Colgate-Palmolive |
CL |
$10,000 |
$36,108 |
261% |
|
Bank of America |
(NYSE:BAC) |
$10,000 |
$34,766 |
248% |
|
Pfizer |
(NYSE:PFE) |
$10,000 |
$27,165 |
172% |
|
Verizon |
(NYSE:VZ) |
$10,000 |
$17,925 |
79% |
|
S&P 500 Index |
$10,000 |
$19,634 |
96% |
Five of the six outperformed the market -- and you wouldn't have to channel the ghost of Benjamin Graham to realize that Colgate-Palmolive might deliver high returns. According to Wharton professor Jeremy Siegel's book The Future for Investors, it was of the best-performing stocks in the market from 1957 to 2003! Recent strength in the energy and financial areas led to big gains for ConocoPhillips and Bank of America. Once again, no surprises there. My hunch is that the health-care industry will experience similar strength over the next decade (indeed, Foolish analyst Nate Parmelee chose a "diversified medical giant" for the Fool's Blue Chip Report 2006).
How can Fools beat the market?
We've written often about Professor Siegel's research, which shows that the highest dividend yielders of the original S&P 500 handily outperformed the market average over the long haul. A major reason blue chips can anchor a portfolio is dividends. The above-listed companies all have steady, growing dividends that can juice your returns in bull markets and protect you in bear markets. Those dividends translate to cash, so you're getting the capital gains potential of some of America's strongest companies as well as the only sure thing the market has to offer: cash.
Now's a good time
The summer struggles of the stock market at large have hit some steady blue chips -- hard. Many are trading for their lowest multiples in five years. So now is a good time to go shopping.
If you want an assist in that mission, the Fool released its second-annual blue-chip report, 10 Monster Stocks to Anchor Your Portfolio, which features 10 solid companies, as well as a bonus blue-chip mutual fund. We think we have chosen 10 of the best companies in the world, stocks that offer the promise of high returns with below-market levels of risk. If you want to check out our research in Blue Chip Report 2006, just follow this link for more information.
This article was originally published on June 28, 2005. It has been updated.
At the time of publication, John Reeves didn't own shares of any of the companies mentioned in this article. Pfizer and Colgate-Palmolive are Motley Fool Inside Value recommendations. Taser is a Motley Fool Rule Breakers selection. Bank of America is a Motley Fool Income Investor choice. The Fool has adisclosure policy.
