The Benefits of Owning Blue-Chip Stocks
Why You May Want to Invest in Established, Profitable Companies
A blue-chip stock is a nickname given to the common stock of large companies with an established track record of growth. These stocks tend to be more expensive to buy, but they're a popular choice because of their stability and slow, steady growth.
Their steady growth makes them a good choice for investors planning for the long term. Learn more about why you might want to add these stocks to your portfolio.
What Are Blue-Chip Stocks?
The term "blue-chip stock" comes from poker, where the most valuable playing chip color is blue. 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, but generally speaking, blue-chip stocks/companies have an established record of stable earning power over several decades. They typically boast a long record of uninterrupted dividend payments to common stockholders.
These stocks 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. They sport a rock-solid balance sheet and income statement.
Blue-chip firms are substantially larger than the typical corporation, often ranking among the world's largest enterprises. They typically possess a 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, franchise value in the mind of the consumer, or ownership of strategically important assets such as choice oil fields.
These firms regularly repurchase stock when the share price is attractive relative to owner earnings and issue bonds that are considered investment grade, with the best of the best being Triple-A rated.
Why Blue Chip Stocks Are Popular
One of the reasons investors love blue-chip stocks so much is that they tend to have steady rates of return. The journey isn't always smooth, especially when there's an economic downturn, but these companies turn a predictable profit over time.
They also aren't volatile. Newer companies may experience ups and downs as they become established. You may see dramatic swings in value, which can be stressful and make it difficult to know when to buy or sell. Blue-chip stocks may change in value, but you're unlikely to see dramatic swings in price.
Finally, investors tend to love blue-chip stocks because the stability and strength of the financial statements mean that their passive income from dividends 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 across the board, investors probably have much bigger things to worry about than the stock market. We're most likely looking at a civilization-ending-as-we-know-it set of circumstances.
Examples of Blue-Chip Stocks
Many blue-chip stocks are familiar names, including corporations such as:
- Amazon (AMZN): Amazon was founded in 1994 by Jeff Bezos. It started as a bookseller but has expanded into selling just about everything. Its low prices and infrastructure give it its competitive advantage, and as of December 2020, it's worth $1 trillion.
- Alphabet (GOOGL): Alphabet is a holding company that operates Google, Android, and Chrome and lesser-known companies like Verily and Waymo. As of December 2020, it's also worth $1 trillion.
- The Coca-Cola Company (KO): Few companies are better known than Coca-Cola. Today, Coca-Cola is a global company with more than 700,000 employees across the company and its bottling partners. As of December 2020, it's worth $229 billion.
From time to time, you'll find a situation where a former blue-chip stock goes bankrupt, such as the demise of Eastman Kodak in 2012. 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.
Blue-Chip Stocks as Part of a Diversified Portfolio
The reality is that if you are reasonably diversified, hold for a long enough period, and buy at a reasonable price, 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, 1973-1974, and 2007-2009, which were periods during which many investors watched 1/3 or 1/2 of their wealth disappear right before their eyes in terms of quoted market value. That's part of the trade-off. Those times will return, again and again. If you hold equities, you will experience that pain.
That's why it's essential to keep in mind that blue-chip stocks are typically part of a buy-and-hold strategy with a longer timeline. They can be a valuable part of a diversified portfolio that includes lower-risk investments like bonds.