What Is a Blue Chip?
A blue chip is a nationally recognized, well-established, and financially sound company. Blue chips generally sell high-quality, widely accepted products and services. Blue-chip companies are known to weather downturns and operate profitably in the face of adverse economic conditions, which helps to contribute to their long record of stable and reliable growth.
- A blue-chip stock refers to an established, stable, and well-recognized corporation.
- Blue chips are characterized by a high market capitalization, a listing on a major stock exchange, and a history of reliable growth and dividend payments.
- Blue-chip stocks are seen as relatively safe investments, with a proven track record of success and stable growth.
- Although blue chips are reliably stable, they are unlikely to generate the same high returns as potentially riskier investments.
- Blue-chip stocks are still nonetheless subject to volatility and failure, such as with the collapse of Lehman Brothers or the impact of the financial crisis on General Motors.
Understanding Blue Chips
The term "blue chip" was first used to describe high-priced stocks in 1923 when Oliver Gingold, an employee at Dow Jones, observed certain stocks trading at $200 or more per share. Poker players bet in blue, white, and red chips with the blue chips having more value than both red and white chips. Today, blue-chip stocks don’t necessarily refer to stocks with a high price tag, but more accurately to stocks of high-quality companies that have withstood the test of time.
A blue-chip stock is generally a component of the most reputable market indexes or averages, such as the Dow Jones Industrial Average, the Standard & Poor's (S&P) 500 and the Nasdaq-100 in the United States, the TSX-60 in Canada, or the FTSE Index in the United Kingdom. How big a company needs to be to qualify for blue-chip status is open to debate. A generally accepted benchmark is a market capitalization of $5 billion, although market or sector leaders can be companies of all sizes.
Many Conservative investors with a low risk profile or nearing retirement may usually go for blue-chip stocks. These stocks are great for capital preservation and their consistent dividend payments not only provide income but also protect the portfolio against inflation. In his book The Intelligent Investor, Benjamin Graham points out that conservative investors should look for companies that have consistently paid dividends for 20 years or more.
Examples of Blue Chip Stocks
A blue-chip company is a multinational firm that has been in operation for a number of years. Think companies like Coca-Cola, Disney, PepsiCo, Walmart, General Electric, IBM, and McDonald’s, which are dominant leaders in their respective industries.
Although it is not strictly a requirement, blue-chips usually trade on a major stock exchange such as the New York Stock Exchange or the Nasdaq. They are often listed in a market index such as the S&P 500, the Nasdaq 100, or the Dow Jones Industrial Average.
The name "blue chip" came about from the game of poker in which the blue chips have the highest value.
Characteristics of Blue Chip Stocks
Blue-chip stocks are seen as less volatile investments than owning shares in companies without blue-chip status because blue chips have an institutional status in the economy. The stocks are highly liquid since they are frequently traded in the market by individual and institutional investors alike. Therefore, investors who need cash on a whim can confidently create a sell order for their stock knowing that there will always be a buyer on the other end of the transaction.
Blue-chip companies are also characterized as having little to no debt, large market capitalization, stable debt-to-equity ratio, and high return on equity (ROE) and return on assets (ROA). The solid balance sheet fundamentals coupled with high liquidity have earned all blue-chip stocks the investment-grade bond ratings. While dividend payments are not absolutely necessary for a stock to be considered a blue chip, most blue chips have long records of paying stable or rising dividends.
An investor can track the performance of blue-chip stocks through a blue-chip index, which can also be used as an indicator of industry or economic performance. Most publicly traded blue-chip stocks are included in the Dow Jones Industrial Average (DJIA), one of the most popular blue-chip indices. Although changes made to the DJIA index are rare, an investor tracking blue chips should always monitor the DJIA to stay up to date with any changes made.
Blue-Chip Stocks' Safety
While a blue-chip company may have survived several challenges and market cycles, leading to it being perceived as a safe investment, this may not always be the case. The bankruptcies of General Motors and Lehman Brothers, as well as a number of leading European banks during the global recession of 2008, show that even the best companies may struggle during periods of extreme stress.
While blue-chip stocks are appropriate for use as core holdings within a larger portfolio, they generally shouldn't be the entire portfolio. A diversified portfolio usually contains some allocation to bonds and cash. Within a portfolio's allocation to stocks, an investor should consider owning mid-caps and small-caps as well.
Younger investors can generally tolerate the risk that comes from having a greater percentage of their portfolios in stocks, including blue chips, while older investors may choose to focus more on capital preservation through larger investments in bonds and cash.
Advantages and Disadvantages of Blue Chip Stocks
Because blue-chip companies are well-established in their industries, they are also considered an effective way to invest capital at relatively low risk. Blue-chip companies provide reliable growth and dividend payments and tend to have low volatility. Moreover, because these companies have reliable cash flows and a long history of paying off their debts, they are unlikely to suffer from a sudden credit or liquidity crunch.
The downside is that because blue chips are low risk, they also tend to have low returns. Since these companies are well-established in their industries, they also have less room to grow than smaller startups. Moreover, because their stocks are in such wide demand, blue chip stocks tend to be more expensive than other companies of comparable size.
Pros and Cons of Blue Chip Stocks
Lower risk than other stocks.
Reliable returns and dividends.
Returns tend to be lower than less established companies.
Blue chip companies have less room to grow, meaning that they are unlikely to see large gains.
Because they are in high demand, blue chips tend to be more expensive than comparable stocks.
Blue Chip Funds
In addition to buying individual stocks, you can also invest in a fund that targets large-cap companies or market leaders. Many of these companies are considered blue-chip stocks, but these funds also include other companies.
There are also mutual funds that specifically target blue-chip companies, allowing investors to gain exposure to an entire basket of blue-chip stocks with a single investment. Most asset managers, such as Fidelity and BlackRock, offer one or more blue-chip-focused funds.
What Are Some Blue Chip Stocks?
Common examples of blue-chip stocks are market leaders like IBM, General Motors, Coca-Cola, or McDonald's. These are companies with a long track record of steady growth and low volatility, suggesting that they are unlikely to face major problems in the near future. Blue chips are characterized by a high credit rating, large market capitalization, a listing on the NYSE or another major stock exchange, and are often listed in a major stock market index.
What Is a Blue Chip NFT?
A "blue chip NFT" is a digital artwork or collectible issued by one of the more reputable players in the market for non-fungible tokens. Because these companies are relatively well-established in the NFT space, they are considered less risky than some of their upstart competitors. However, because digital assets are an extremely new and risky market, it may be a stretch to apply the "blue chip" label to such a speculative asset.
How Do You Invest in Blue Chip Stocks?
You can invest in blue-chip stocks through a stock brokerage such as Fidelity or Charles Schwab. Simply search for the company's ticker symbol in the broker's stock screener. In addition, many asset managers also run mutual funds or index funds that specifically target blue-chip securities, making it easy to invest in a basket of such companies.
Where Do Blue Chip Stocks Get Their Name?
The term "blue chip" comes from the game of poker, where blue chips are usually the most valuable ones on the table. It was first used by Oliver Gingold, an employee at Dow Jones, who observed that certain stocks reliably traded above $200 per share. Nowadays, some blue chips trade in the thousands per share.
The Bottom Line
"Blue chip" is an informal term for the most reliable and valuable companies on the market. These are usually companies with a long track record of financial stability, and they are usually leaders within their industry. For that reason, they are often sought after and considered very low-risk investments.