The Benefits of Owning Blue Chip Stocks

Investing in Profitable, Long-Established Companies Can Be a Lucrative Decision

The Benefits of Investing in Blue Chip Stocks
Investing in blue chip stocks can be one of the most profitable things a person can do over their lifetime if they are careful to select a basket of shares in strong companies at reasonable valuations and a history of paying out the increasing profits in the form of cash dividends. DNY59 / Getty Images

Investing in blue chip stocks may have a reputation as boring, stodgy, and perhaps even a little outdated but it isn't an accident that they are overwhelmingly preferred by wealthy investors and rock-solid financial institutions.  You would think that anyone with common sense when want a stake in businesses they not only understand but that have a demonstrated record of extreme profitability over generations and they certainly fit the description - measured across long periods, blue chip stocks have minted money for owners prudent enough to hang on to them with tenacity through thick and thin, good times and bad times, war and peace, inflation and deflation.

 And it isn't as if they are unknown.  They are ubiquitous; taken for granted.  Blue chip stocks often represent companies residing at the core of American and global business; firms boasting pasts every bit as colorful as any novel and interwoven with politics and history.  They provide the goods and services that make up the backdrops of our lives. 

How is it possible, then, that blue chip stocks have long reigned supreme in the investment portfolios of retirees, non-profit foundations, as well as members of the top 1% and the capitalist class, while being almost entirely ignored by smaller, poorer investors?  This conundrum gives us a glimpse into the problem of investment management as it is and even requires some discussion of behavioral economics.  This afternoon, I want to talk to you about blue chip stocks to try and get you to rethink your position if you are one of those misguided investors who has written them off as something belonging exclusively to the realm of widows and insurance companies.


Before We Can Discuss the Benefits of Investing in Blue Chip Stocks, We Need To Answer a Question: "What Is a Blue Chip Stock?"

Although there is no need to completely re-visit ground we've already covered given that I wrote an in-depth overview in an article titled, appropriately enough, What Is a Blue Chip Stock?, at its core, a blue chip stock is a nickname given to the common stock of a company that has several quantitative and qualitative characteristics.

 The term "blue chip" comes from the card game poker, where the highest and most valuable playing chip color is blue.

Although there is no universal agreement on what, precisely, makes up a blue chip stock, and there are always individual exceptions to one or more rules, generally speaking, blue chip stocks:

  • Possess some sort of major competitive advantage that makes it extraordinarily difficult to unseat market share from them, which can come in the form of a cost advantage achieved through economies of scale, a franchise value in the mind of the consumer, or ownership of strategically important assets such as choice oil fields;
  • Issue bonds that are considered investment grade with the best of the best being Triple A rated; and
  • Are included, domestically at least, in the component list of the S&P 500 index.  Many of the bluest of the blue chips are included in the more selective Dow Jones Industrial Average.

Here's Why Blue Chip Stocks Are So Popular With Wealthy and Experienced Investors

One of the reasons wealthy investors love blue chip stocks so much is because they tend to compound at acceptable rates of return - typically between 8% and 12% historically with dividends reinvested - for many decades.

 The journey isn't smooth by any means, with drops of 50% or more lasting several years along the way, but over time, the economic engine that produces the profits exerts its extraordinary power and it shows up in the total return of the shareholder, presuming that shareholder paid a reasonable price.  (Even then, that isn't always a requisite.  As history has shown, even if you paid stupidly high prices for the so-called Nifty Fifty, a group of amazing companies that was bid up to the sky, 25 years later, you actually beat the stock market indices despite several of the firms on the list going bankrupt.)

By holding the stock directly, and allowing enormous deferred tax liabilities to build up, the wealthy can die with the individual stocks still in their estate, passing them on to their children using something known as the stepped-up basis loophole.  Effectively, as long as you are still under the estate tax limits, when this happens, all of the deferred capital gains taxes that would have been owed are forgiven.  It's one of the most incredible, long-standing, traditional benefits available to reward investors.  To provide an example, if you and your spouse acquired $500,000 worth of blue chip stocks and held on to them, dying after they had grown in value to $10,000,000, you could arrange your estate in a way that the capital gains that would have been owed on the $9,500,000 unrealized gains are instantly forgiven.  You would have never paid them.  Your children will never have to pay them.  It's such a big deal that you're often better compounding at a bit lower rate with a holding you can maintain for decades than trying to flit in and out from position to position.

Another reason is that blue chips stocks offer somewhat of a relatively safe harbor during economic catastrophes, especially if coupled with gilt-edged bonds and cash reserves.  Inexperienced and poorer investors don't think about this too much because they​ are almost always trying to get rich too quickly, shooting for the moon, looking for that one thing that will instantly make them rich.  It hardly ever ends well as you learned here and here.  Markets will collapse.  You will see your holdings drop by a substantial amount no matter what you own.  If anyone tells you otherwise, they are either a fool or trying to deceive you.  Part of the reason is that dividend-paying stocks tend to fall less in bear markets due to something known as yield support.  Another part is that large, profitable blue chips sometimes benefit over the long-run from economic trouble as they can buy or drive out of business weakened or bankrupt competitors at attractive prices.  As I explained in a long essay on the nature of investing in the oil majors, a company like Exxon Mobil paradoxically sets the stage for much better results decades down the line whenever there is a major oil collapse.

Finally, wealthy and successful investors tend to love blue chip stocks because the stability and strength of the financial statements mean that the passive income is hardly ever in danger, especially if there is broad diversification in the portfolio.  If we ever get to the point that America's premier blue chips are cutting dividends en masse across the board, investors probably have much bigger things to worry about than the stock market.  In fact, we're most likely looking at a civilization-ending-as-we-know-it set of circumstances.

What Are the Names of Some Blue Chip Stocks?

Despite there not being universal agreement about what constitutes a blue chip stock, generally, some names you are going to find on most people's list, as well as the rosters of white-glove asset management firms, include corporations such as:

  • The Coca-Cola Company
  • PepsiCo
  • Nestle SA
  • Johnson & Johnson
  • Berkshire Hathaway
  • Wells Fargo & Company
  • Diageo
  • Procter & Gamble
  • Colgate-Palmolive
  • The Clorox Company
  • Kraft Heinz
  • McDonald's Corporation
  • American Express
  • Boeing
  • Chevron
  • Exxon Mobil
  • General Electric
  • 3M
  • United Technologies
  • AT&T
  • Visa
  • The Hershey Company
  • The Walt Disney Company
  • Wal-Mart Stores

From time to time, you'll get a situation where a former blue chip stock goes bankrupt, such as the demise of Eastman Kodak.  However, as surprising as it may sound, even in cases like that, long-term owners can end up making money due to a combination of dividends, spin-offs, and tax credits.

The reality is that if you are reasonably diversified, hold for a long enough period of time, and buy at a price so the normalized earnings yield of the blue chip stocks is reasonable relative to U.S. Treasury bond yield, short of a catastrophic war or outside context event, there has never been a time in American history where you'd have gone broke buying blue chip stocks as a class.  Sure, you had periods like 1929-1933 and 1973-1974; periods during which you wanted 1/3rd or 1/2 of your wealth ​to disappear right before your eyes in terms of quoted market value.  That's part of the trade-off.  Those times will return, again.  If you hold equities, you will experience that pain.  Deal with it.  Get over it.  If you think it can be avoided, you shouldn't own stocks because you are fooling yourself.  To the true buy and hold investor, it doesn't mean much; a blip on the multi-generational holding chart that will eventually be forgotten.  After all, who remembers Coca-Cola losing around 50% of its value due to the sugar crisis shortly after its IPO?  Yet, a single share bought for $40, which crashed down to $19, is now worth more than $15,000,000 with dividends reinvested.