What are Blue Chip Stocks?
Find out what blue chip stocks are, their benefits and drawbacks and the type of investors who generally invest in these stocks.
June 9, 2022
This article is provided for informational purposes only and should not be construed as legal or investment advice. Consult with a professional financial or investment advisor before making investment decisions.
In the investing world, there are a few different kinds of stocks that you will often hear about, like "blue chip" stocks. But what actually are blue chip stocks?
Blue chip stocks are the stocks of large, well-established companies that have a proven track record of profitability, long and sustained growth, and a reputation for being leaders, or at the very least, holding important positions in their respective industries. These companies are known to endure economic downturns and even operate profitably in such conditions. Additionally, many blue chip companies have a long history of consistent and rising dividend pay-outs to shareholders.
Though no investment is ever 100% without risk, and past performance is never a guarantee of future results, blue chip stocks are generally considered to be some of the safest and most reliable investments that one could invest in.
So what else do you need to know about blue chip stocks? Keep reading.
Blue chip stocks: Where does the name come from?
The term “blue chip” comes from gambling, more specifically poker, where the most valuable plastic chips that are used in place of money are blue chips.
Oliver Gingold, an employee of the Dow Jones, used the term sometime in 1923 or 1924 in reference to high-priced stocks, i.e., stocks that were trading at $200 or more per share. Today, the term is more commonly used to refer to high-quality stocks.
What makes a stock "blue chip?"
There are no hard and fast rules for designating a company as blue chip. Companies with blue chip designation, however, tend to share some common characteristics that include:
Large market capitalization
Leaders (or very important players) in their respective industries
Relatively stable earnings track record
Solid record of sustained growth
Solid reputation build over several decades
No major outstanding liabilities
Many (but not all) blue chip companies also make regular and often rising dividend pay-outs to shareholders, including when the economy is moving adversely.
Furthermore, many blue chip companies are constituents of major stock market indexes such as the Dow Jones Industrial Average (DJIA), the S&P 500 and the Nasdaq 100.
What are blue chip stocks in the U.S.?
Blue chip stocks include household names that you have most likely heard of, and whose products or services you have most likely purchased, used or come into contact with. Here are few examples:
Johnson and Johnson
Proctor and Gamble
Can a company fall out of blue chip status?
Companies can lose their blue chip status or designation over time.
For example, Kodak, the imaging products company, and Sears, the department store retailer, were once among the most powerful blue chip companies in the U.S. Both companies declared bankruptcy in the 2010s and are no longer considered blue chips.
Tough economic conditions, poor management, shifting market dynamics and other negative forces can cause a company to lose its blue chip status.
What kind of investors do blue chip stocks appeal to?
Blue chip stocks have several benefits that make them appealing to different types of investors.
For example, the reliability and stability of blue chip stocks, even in the midst of adverse economic conditions, means that they are quite popular among conservative and risk-averse investors who are looking for stability and steady long-term growth.
The fact that most also pay regular and often growing dividends means that they are also quite popular among investors looking for steady income.
Generally speaking, blue chip stocks are typically used for long-term investment purposes. Due to their low risk, they offer a way to get a moderate, but reliable rate of return.
What are the drawbacks of blue chip stocks?
While blue chip stocks may be less volatile and more reliable than other types of stocks, they do not always provide the highest returns. Because of their size and maturity, these companies are unlikely to experience the kind of rapid growth that smaller or start-up companies may experience, which could translate to large returns in the short term.
Consequently, blue chip stocks might not be as appealing to short-term traders seeking high returns in a short period of time. These kinds of investors may prefer small or mid-cap stocks, which have a higher potential for large price moves or rapid growth in the short term.
Blue chip stocks also sell at a premium compared to other stocks. Indeed, the cost of a single share of a blue chip company can be in the hundreds, if not thousands, of dollars. As a result, most retail investors might not be able to acquire big stock positions in blue chip companies.
Fortunately, many brokerages now allow you to purchase fractional shares of most blue chip companies in the US. So, you can still own a piece of your favorite blue chip company even if you only have a small amount to invest.
What other stock designations are there?
Besides blue stocks, there are several other stock designations.
These are low-priced stocks that typically trade for less than $5 per share. Penny stocks are usually issued by small or unproven companies.
These are stocks that are expected to grow at a faster rate than the overall market. Unlike blue chip stocks, growth stocks do not pay dividends. That’s because most reinvest a large portion of their profits back into the business to help them grow.
Value stocks are stocks that appear to be undervalued at the moment on the market. They could be stocks of previously successful companies that are currently experiencing temporary difficulties such as cash flow issues or poor sales but that investors believe will make a comeback later.
Overall, blue chip stocks are stocks of prestigious, well-established companies that have proven themselves as good and relatively safe investments over the years.
That, however, doesn’t mean that blue chip stocks are immune to market crashes, bankruptcy, or that they can’t go down in value ever – they definitely can, and some even have in the past.
So it’s important for anyone thinking of investing in these stocks to do their own research before making any decisions and seek professional advice if necessary.
If you're new to investing, check out our Investing 101 Guide for a good introduction to the basics.
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