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If you’re looking for safe, reliable, and profitable investment options, consider blue chip stocks. These companies are the hallmarks of their industries, offering low volatility and strong returns over the long haul.
If you’ve done any research on the stock market, you’ve heard the term “blue chip” and probably wondered what it means. Also, how did these stocks come by that nickname? Let’s dive in so you can get a better idea of the term and how it applies to investing.
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What's a blue chip stock?
If you’re going car shopping, blue chip stocks aren't the sports cars. They're the reliable four-door sedan with all the bells, whistles, and safety features that will protect you and your family.
The name “blue chip” originates from high-stakes poker, where blue-colored chips have the highest face value. Investing can seem like gambling in some aspects with high stakes and uncertain investments—blue chip stocks can be the equivalent of a royal flush, especially in an uncertain market.
You're likely familiar with many blue chip companies without realizing it. Household names such as General Mills, Apple, Google, and Disney are just some of the stocks considered safe and secure by investors, and thus “blue chip.” These stocks tend to follow a large cap index like the S&P 500 or Russell 1000 very closely. But just because a company is a household name doesn’t make it automatically blue chip. For example, Apple was not given blue chip status until 2015.
Here are some traits that blue chip stocks have in common:
Stable growth rate: Stocks of well-established companies tend to have a strong long-term record of continued growth. They're not as volatile as less established companies and command a large share of the market.
Large market cap: Blue chip companies tend to have large market values of $10 billion or more. This puts them in the large market cap category, which measures the size and value of a company.
Market index: The stocks of blue chip companies are usually part of a large market index such as the S&P 500 or the Nasdaq 100. Their value tends to follow the rise and fall of the market closely.
Many blue chip companies also pay dividends to investors. Dividends are regular payments from a company’s revenue. Since the companies are well-established, they do not need to invest as much back into their growth and instead can share profits with investors.
Blue chip vs penny stock
According to the Securities and Exchange Commission (SEC), a penny stock is a security issued by a company with small market value that trades for less than $5 per share. Some experts set the cut-off even lower: at $1 or less.
Since penny stocks have such a low value, they are often traded off major market exchanges. For example, Nasdaq has a rule that if a stock falls below a minimum bid price of $1 per share for 30 consecutive days, it risks being de-listed from the exchange.
In short, penny stocks are the opposite of blue chip stocks. They are issued by companies that have little or no financial history or may be close to bankruptcy. Investors who buy penny stock shares count on the company making a turnaround so they can get a return on the money.
In contrast, blue chip stocks offer steady earning results year after year. They won’t shoot up in value overnight but provide investors with a stable return on their money. Blue chip stocks tend to offer good diversification during recessions since their household name status likely means continued demand even in down times.
But just because a company is considered blue chip that doesn’t mean it’s immune to economic conditions. The shares of any company, even established ones, can take a hit and lose value.
For example, even though investment firm Goldman Sachs (GS) is considered a blue chip stock today, it took a big hit during the Great Recession. It was part of the subprime mortgage crisis that led to the stock market crash of 2008, which caused its shares to lose value.
Should I buy blue chip stock?
If you want to balance out your portfolio by adding stable, safe stocks with a long history of steady growth, blue chip shares can be a good option. Even though these stocks are considered reliable, think twice before having all of your eggs in one basket.
No company is safe from market downturns or economic pressures. Just because a stock has offered steady returns in the past doesn’t mean it will continue to do so in the future. Do your research before spending any money buying individual stocks.
Most investors will do well with a diversified mix of investments that includes blue chip stocks as part of the overall portfolio and not the focus. A good option to get you started is Wealthsimple Invest, which simplifies the process and makes it easy to get started.
Buying blue chip stocks
Buying individual stocks, blue chip or not, takes time and research. Start by looking at the big players in the market: companies that have been around for decades and have weathered different market conditions.
Use the company’s 10K filing as a good starting point for information on past, current, and future performance. Review the company’s financials, growth over time, current outlook, and plans for the future.
When it comes to blue chip stocks, you can either buy individual shares of companies like Johnson & Johnson or Home Depot or go with an index fund. Blue chip index funds or exchange-traded funds (ETFs) follow the performance of a specific stock market segment.
Large cap index funds or ETFs are another good way to get exposure to blue chips in your investment portfolio. That’s because most blue chip companies have large market caps and would be part of those funds.
In addition, index funds or ETFs that track the S&P 500 or the Nasdaq 100 also include shares of blue chip stocks. Since these funds include other companies beyond blue chips, they can help you diversify your investments further.
The bottom line on blue chip stocks
Investing in blue chip stocks is a good way to diversify your portfolio with companies that offer safe, stable, and reliable returns over the long term. They are not “flashy,” but many pay dividends to investors every quarter.
Just because a company’s stock is blue chip, that doesn’t mean it’s immune to market conditions or economic downturns. Never put all of your eggs in one basket but consider adding blue chip stocks or funds to your investment portfolio.
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