What is a Blue-Chip Stock?
A blue-chip stock is a huge company with an excellent reputation. These are typically large, well-established and financially sound companies that have operated for many years and that have dependable earnings, often paying dividends to investors. A blue-chip stock typically has a market capitalization in the billions, is generally the market leader or among the top three companies in its sector, and is more often than not a household name. For all of these reasons, blue-chip stocks are among the most popular to buy among investors. Some examples of blue-chip stocks are IBM Corp., Coca-Cola Co. and Boeing Co.
Understanding a Blue-Chip Stock
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. The term is believed to have been derived from poker, where blue chips are the most expensive chips.
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. The $64.2 billion T. Rowe Price Blue Chip Growth Fund doesn't have a specific guideline for what type of company qualifies outside of focusing on large-cap and mid-cap companies that are well-established in their industries, although the median market cap of the fund's holdings has historically been in the range of close to $100 billion.
- Blue-chip stocks are huge companies with excellent reputations, often including some of the biggest household names.
- Investors turn to blue-chip stocks because they have dependable financials and often pay dividends.
- There is a perception among investors that blue-chips can survive market challenges of many kinds; while this may be largely true, it is not a guarantee. For this reason, it's crucial to diversify a portfolio beyond only blue-chip stocks.
The Safety of Blue-Chip Stocks
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, is proof that even the best companies may struggle during periods of extreme stress.
Blue Chips as Part of a Larger Portfolio
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.