A blue-chip stock is defined as a big, well-established, and highly reputable company that has a long history of growing profits, while mostly holding a long record of consistent dividend payments. Blue-chip companies are usually known for their lead positions in their operating industry and big market capitalizations of at least billions of dollars.
Blue-chip stocks are especially popular among investors since they have proven to mostly provide consistently great returns for their shareholders as a result of their immense growth and attractive dividends. Because of their sound financial fundamentals and great market capitalization, blue-chip companies are expected to sustain tough market conditions and economic downturns at a better level than other companies.
Since blue-chip stocks represent well-known companies across the world, you will most likely come across blue-chip names in your everyday life and chances are that you’ve already used their product and services in any way. Blue chips often get the most amount of attention from financial news and media and are thus often considered as good investments by the majority of people.
Why Blue Chip?
The reference for ‘blue-chip’ comes from the game of poker since the blue chips are actually the ones with the highest value out of all the other colors. In 1923, Oliver Gingold, who was working at Dow Jones at that time, noticed that some stocks were trading at $200 and above per share and wrote an article about them, while calling them ‘blue chips’ because of their high value.
Since that time, the term has become established as a reference for expensive stocks. That being said, investors usually don’t simply refer to blue chips as pricey stocks in today’s times but rather as high-quality companies with a long history of profitability and sound fundamentals.
The Pros and Cons of Blue Chips
Blue-chip companies aren’t necessarily always the best investments. There are definitely positive characteristics and benefits of owning a blue-chip stock but blue-chip companies as investments may come with drawbacks that other stocks may not have. Some of the points that include the great characteristics of blue-chips are
Solid financial performance. Blue-chip companies are known for their long history of strong financial growth and performance, which has provided consistent and stable returns to investors. Many investors also view blue-chip companies as especially “safe” because of their high reputation, experienced management, and their lead position within their industry. This is why most investors expect blue-chip companies to have the highest probability to withstand and recover from a bear market and tough market conditions. As already mentioned, blue chips usually have huge market capitalization and a well-established name in the world, which adds up to the stableness of those businesses.
Steady dividends. While it is not a requirement for a blue-chip company to pay dividends, most blue chips do pay dividends, which are being distributed to shareholders on a regular basis. The ‘luxury’ of investors to consistently receive increasing dividends is oftentimes not the case for smaller companies since those usually prefer to reinvest all their earnings into their growth.
Dividends can add up to a much stronger return for an investment portfolio in the long-term. Investors who are consistently reinvesting their dividends will most likely reap noticeable results in the long run compared to investments that don’t pay any dividends.
That being said, there are some drawbacks that don’t necessarily make blue-chip companies the best investments; at least not for everyone. These include
Relatively low growth potential and performance. Blue-chip stocks tend to grow at a slower but stable and reliable rate as opposed to smaller and younger companies since it is harder for them to continue with high growth from their already established leading market position and business size. In order to still attract investors and to return profits to shareholders, most blue-chip stocks provide a consistent dividend instead.
Blue-chip stocks are heavily influenced by the public’s view. Because of their huge and well-known popularity for their products and services across the world, blue-chip companies usually get the most attention from news and media. At first, this may not seem like a problem but this also concludes that stock prices of blue chips are usually heavily influenced by the short-term view of the public. This makes blue-chip stocks especially sensitive to any short term incidents and events, as everybody is talking about them.
Why to Invest in Blue Chip Stocks
Investing in blue chips may seem to some investors as a boring and outdated thing to do nowadays. However, blue-chip companies represent major businesses that are respected by huge investors and institutions for their long history of great profitability. Having a good proportion invested in blue chips can give investors a good amount of confidence, not only because of their astonishing financial record and great market share but simply also because they’re understandable, as you’ve most likely at least heard of their product and business and you may have already incorporated blue-chip products and services in your everyday life in some way.
Blue-chip stocks are usually the companies that are most likely to survive a severe market downturn because of their strong financial fundamentals and greatly experienced management. This is why investors oftentimes rather shift to blue-chip companies during economic downturns, as many blue chips proved to be able to recover from an economic downturn thus turning them into ‘safe-havens’ during bad times.
So even if the potential of growth tends offset with blue-chip companies, they still are considered as great investments that can still offer good returns over the long-term, especially with dividends reinvested. Many investors believe that you can’t really go wrong with blue-chip stocks, which is definitely true to some extent. That being said, the stock price at which you buy blue chips is still extremely important, as it does have a great impact on the general investment return. Buying overvalued blue chips will not only reduce future returns but can also come with a certain amount of downside risk.
There are good reasons why blue-chip stocks tend to be popular amongst many investors. They have not only proven themselves to be able to provide shareholders with strong and consistent profits over many years but are also expected to weather heavy market downturns and recover quickly, as a result of their huge market share, experienced management, and leading positions in their industry. As a result, blue chips make up a solid investment within a diversified portfolio along with other stocks and asset classes because of their additional and consistent dividend payouts.