Learn About Blue-Chip Stocks

Understanding What Makes Some Stocks Better Than Other Stocks

What is a Blue Chip Stock?
••• A blue chip is a phrase used to refer to a stock of extraordinarily high quality, including long records of dividend increases, strong balance sheets, and huge competitive advantages that make it almost untouchable in its industry. Sandra Baker/Getty Images

In this introduction to blue chip stocks, you'll learn what makes them so much better than other types of stocks, and how you might go about buying them. It is not an exaggeration to say that it could change your life for the better if you take advantage of acquiring a diversified collection of these wonderful long-term holdings.

These type of holdings have made countless men and women multi-millionaires due to their discipline, patience, and understanding of the power of compounding, including janitors working for near minimum wage. It isn't an accident, after all, that when secret millionaires are uncovered following their death, they almost always hold most of their wealth in blue-chip stocks.

The Definition of a Blue Chip Stock

First thing is first: What is a blue-chip stock? At its core, the term refers to shares of companies that are thought to be significantly safer than a vast majority of stocks due to a combination of factors that include, but are not limited to:

  • Excessive financial strength, either in the form of little to no debt or enormous cash reserves that promise a high probability of surviving even another Great Depression;
  • Near impenetrable competitive advantages that make it possible to earn high returns on equity and/or high returns on assets while keeping others at bay;
  • Lower levels of volatility over long periods of time relative to the stock market as a whole;
  • A history of dividend growth significantly in excess of the rate of inflation, year after year, decade after decade, generation after generation.​

    In the old days blue-chip stocks were known as "bellwether stocks", though the phrase is more commonly used to describe stocks that indicate a change in the economy these days (e.g., if shipping and railroad rates decline, it's a good indication economic activity is also declining and earnings of other firms will fall in future quarters once the numbers have worked their way onto the financial statements).

    Where the Term Blue Chip Stock Originated

    The term "blue chip" comes from poker. Blue chips were the highest value denomination when placing a wager. Accordingly, blue-chip stocks are thought the be the most valuable holdings an investor has in his portfolio; the ones you want to hang on to for life and pass down to your children and grandchildren in trust.

    The Benefits of Investing in Blue Chip Stocks

    Again, this is such an important question. A stand-alone article called The Benefits of Owning Blue Chip Stocks walks you through a bullet point list of some of the appeals these securities hold, such as geographic diversification for firms such as The Coca-Cola Company; a company so prosperous it is thought to profit from roughly 3.5% of all liquids consumed on the planet each day, including tap water, thanks to its portfolio of 500+ beverage brands. Is it really any wonder that a single share bought for $19 in 1919 is now worth more than $10 million with dividends reinvested?

    Finding Blue Chip Stocks for Your Portfolio

    What a fantastic question! There are many places you can start. First, look up the current list of so-called "Dividend Aristocrats" published by research firm Standard and Poors. These are blue chip stocks that have raised their dividend every year for at least a quarter-of-a-century (25 years); an astonishing achievement.

    Next, look through the individual components of both the Dow Jones Industrial Average and the S&P 500, going page by page through something like the Value Line Investment Survey looking for firms with the financial ratios that appeal to you.

    Do not relax your standards when putting together your preliminary list of blue-chip stocks. You're looking for extraordinary enterprises such as Johnson & Johnson, Colgate-Palmolive, and Hershey. You want to know that even if the country goes into the worst economic meltdown in centuries, the odds are decent your checks are going to arrive in the mail like clockwork.