Blue chip stocks are the stocks of high-quality companies that have become leaders in their industries. Named for the traditional color of the most valuable chips at a poker table, blue chip companies are among the most respected in the business world. They've stood the test of time with solid business models that have produced substantial profits and attractive returns for their shareholders. As a result, blue chip stocks are immensely popular among investors.
What makes a blue chip stock?
Blue chip stocks share several traits . Although there's no single universally accepted definition of what makes a blue chip stock, most investors agree that the following characteristics are important for a blue chip company to have:
- A leadership role in their industry. Blue chip stocks have typically been successful in outperforming their competitors and rising to the top of their industries. They don't have to be the single largest player in their field, but they're usually in the running or close behind.
- A high market capitalization. Blue chip companies tend to be large, valuable businesses, and investors recognize their worth by bidding up the share prices. The total value of a blue chip company's stock, as measured by market capitalization, tends to be higher than the market caps of other companies in the same industry and often puts them among the most valuable stocks in the entire market.
- A long history of business growth. Stocks don't become blue chips overnight. It takes consistent growth in revenue and earnings over the long run for a company to become an industry leader, and investors expect blue chip companies to have proven their ability to grow even during tough times in their respective industries and in the overall economy.
- Status as a constituent in a major stock index. Some investors use a very narrow definition of blue chip stocks that simply refers to the 30 companies that make up the Dow Jones Industrial Average (DJINDICES:^DJI). Even if you prefer a broader standard, you'll typically find most blue-chip stocks in popular large-cap stock market indexes like the S&P 500 (SNPINDEX:^GSPC). That's because the selection criteria required to be listed on these indexes are similar to the qualities that give a stock blue chip status.
- Financial stability and strength. Blue chip stocks often have substantial reserves of cash that their businesses generate. They don't have to be free of debt, but they have to be able to manage any debt they have effectively, ideally using it as a means of enhancing their profit potential.
- Dividend payments to shareholders. A stock doesn't have to pay a dividend to be a blue chip, but many blue chip stocks do make dividend payments to their shareholders. The amount of a blue chip stock's dividend can vary widely depending on how mature the business is and how much extra cash it produces. Many top blue chip stocks have long histories of stable or growing dividend payments.
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Why do blue chip stocks make great investments?
The core advantage that blue chip stocks have compared to their peers is the size of their businesses. In order to achieve blue chip status, companies have to demonstrate their ability to outpace their competitors. It takes a long time for a new business to prove itself and become the leader in its field, and that process weeds out many inferior companies that don't have what it takes. Only those businesses that survive the test of time become blue chips, and so investing in these well-established companies after they've already reached the pinnacle of their industries avoids the uncertainty and risk that investors in smaller up-and-coming companies have to accept.
The size of blue chip companies also gives them competitive advantages. Most businesses benefit from economies of scale, meaning that as they grow larger, they can become more efficient and take advantage of opportunities that smaller companies can't. It's easier for blue chip companies to get the capital they need in order to finance new business ventures, either by getting loans from financial institutions or by issuing stock to investors. When blue chip companies do face competitive threats from smaller businesses, they have the resources to take strategic steps to fend off their potential rivals, either by acquiring those competitors or by giving incentives to their rivals' customers to switch their business relationships.
Over time, these advantages give shareholders in blue chip stocks attractive returns on their investment. For instance, the Dow Jones Industrial Average has risen at an average annual rate of roughly 7% over the past 50 years, and its stocks have paid enough in dividends to boost the total return of the blue chip stocks in that benchmark above 10% per year.
Blue chip stocks aren't immune from short-term declines, and some even see their businesses fail. But on the whole, blue chip companies tend to have more secure, stable businesses than other companies, and that relative safety makes them especially attractive for more conservative investors who prefer to minimize their risk when investing in the stock market.
What are some examples of blue chip stocks?
You don't have to be an investor to recognize the names of many blue chip stocks, because their products and services are a part of everyday life for millions of people across the globe. The following companies represent just a handful of the stocks available to investors, but they'll give you an idea of where to look in many of the most important industries in the global economy.
- Coca-Cola (NYSE:KO) is a leader in the beverage industry, with its namesake sugary soft drink having spawned a global empire. The company now sports a broad array of products that encompasses juices, sports drinks, bottled water, and soft drinks of many types.
- JPMorgan Chase (NYSE:JPM) has become one of the largest banks in the world, having survived the financial crisis and reached new heights. With operations that include retail and commercial banking, credit cards, investment banking, and a host of other financial products and services, JPMorgan Chase plays a key leadership role in the banking sector.
- Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) has become a leader in the insurance industry, with well-known investing legend Warren Buffett still at the helm.
- Walt Disney (NYSE:DIS) has become an entertainment titan, combining many interconnected businesses under a single corporate umbrella. With its movie studios, television networks, theme parks, and retail merchandising operations, Disney has mastered the art of touching its customers' lives in many different ways.
- ExxonMobil (NYSE:XOM) is a leader in the global energy industry, with a fully integrated business that includes oil and gas exploration and production, transportation and storage of energy products, and marketing and retail sale of gasoline and other fuels and chemicals to consumers and business customers. Its history dates back to the days of Standard Oil in the 19th century.
How can I invest in blue chip stocks?
Investors who want to add blue chip stocks to their investment portfolios have a number of options. The simplest is just to buy shares of individual stocks directly. By selecting from the companies above as well as other industry leaders, you can put together a diversified portfolio of many different blue chip stocks quite easily.
You can also invest in blue chip stocks by using an index fund that specializes in tracking these leaders. For example, the SPDR Dow Jones Industrial Average ETF (NYSEMKT:DIA) includes four of the five stocks mentioned in the list above, along with more than two dozen other top blue chip companies in industries ranging from manufacturing and healthcare to consumer products and technology.
Blue chip stocks are smart investments for investors of all kinds. Beginning investors might find it more comfortable to buy shares of these blue chip companies with which they're already very familiar. Experienced investors can more deeply appreciate the attractive features that blue chip stocks offer investors, having seen firsthand how they have outperformed their rivals to achieve their current status. If you want stability and reliability among your investments, blue chip stocks are a great place to look.
