You’ve probably heard the term used by financial analysts and in investing discussions. But what is the true definition of a blue chip stock? Blue chips are established companies that generally have a large market cap and are profitable. A great example of this are most of the stocks that are components of the Dow Jones Industrial Average. Overall they are safe, solid investments that can usually be counted on for steady growth and returns.
What Is a Blue Chip Stock?
How did they get their name? The term blue chip is actually a poker reference. Not that we’re comparing the stock market to gambling.
In poker, the blue chip is the highest valued chip ahead of other colors like red and white. It’s a simple term that is now widely used in other industries as well.
But let’s dive a little deeper into this market and see if blue chip stocks are right for you.
Are Blue Chip Stocks a Good Investment?
Anytime we recommend an investment we need to preface it with some stipulations. A good investment depends on the investor. Everyone has a different risk tolerance, investment goal, and investing horizon. What is a good investment for you might not be for your friend, your parents, or your children.
With that being said, blue-chips are generally seen as good investments in the stock market. Is there any harm in owning the most powerful and profitable companies in the world?
After all, when choosing stocks, generally we want to choose ones who are close to guaranteeing a profit in the future. Here are some reasons why these stocks make great investments for any portfolio!
There is no doubting the stability of a blue chip company. Something very drastic would have to happen for these companies to go out of business.
Even in a market downturn like we are seeing now, most blue chip stocks can somewhat hold their values.
They are rock solid companies that are profitable and usually have high cash flow and a strong industry moat.
Most blue chips will also pay you a quarterly dividend. This is a classic sign of a business that has high cash flow, and uses its profits to reward its shareholders.
Collecting dividends can help compound your investments and either grow your positions in these stocks or diversify to others.
Long-Term Capital Gains
Blue chip stocks are investments that you can just set and forget. These companies often have no problems beating quarterly earnings expectations. They also have strong management teams that can continue to innovate and keep the underlying business competitive.
You don’t necessarily want your entire portfolio to be made up of blue chips. But allocating a percentage of your investments to blue chips will help add that level of long-term stability to your holdings.
What Are the Downsides of Blue Chip Stocks?
As I mentioned, blue chip stocks aren’t for everyone! If you are a 20-year old investor that is looking to grow long-term wealth, then blue chip stocks might not be your first choice. Here are some negatives to investing in blue chip stocks.
They Are Boring
Let’s be honest, this is likely the first thing most of us think when we hear the term blue chip. They are boring investments that never really do anything. Of course, we are generally taking this perspective when we have a short-term investing horizon in mind.
But it is the truth and some investors like boring because boring investments are usually safe. Nobody says investing in blue chips is exciting, but over the course of years or even decades, they are about as steady as they come for growing your wealth.
Gains Are Minimal
Also very true. Blue chips have very little volatility. This is great for protecting your downside, but also severely limits your upside. You generally won’t be making 100% gains over the short-term with blue chip stocks.
These are long-term compounders that really test the ‘time in the market’ saying. You won’t see many traders choosing blue chips as a scalp trade or even a day trade.
They Can Be Expensive
Not on a multiple basis but a stock price basis. A lot of blue chip stocks tend to be priced at over $100 per share. While that doesn’t seem like much, for new investors it can be difficult to allocate much capital to these stocks.
Of course you can buy fractional shares or an ETF, but if you want to hold these blue chip stocks it will cost you! You can also take a look at options on these more expensive stocks.
Options allow you to trade higher price stocks for less money. However, options aren’t as cut and dry as stocks. So make sure you start out with a basic options course to help you learn the ins and outs of options trading.
What Are the Best Blue Chip Stocks?
Ah yes the stock recommendations. Take these with a grain of salt because there is never a ‘best’ stock. Some criteria I look for when I research blue chip stocks is profitability, cash flow, moat, and of course, dividends. Not all young investors like dividend stocks, but I do! Here’s a short list of some of the best blue chip stocks on the market!
Apple (NASDAQ: AAPL)
A lot of people have not grown accustomed to calling tech stocks blue chips.
But you can argue that the big tech stocks are the blue-chip stocks of the next generation.
Apple is a component of the Dow Jones and is the largest weighted component of both the S&P 500 and the NASDAQ. It’s safe to say Apple has a major influence over the US equities market.
Coca Cola (NYSE: KO)
Coca Cola might be the epitome of the boring blue chip stock. It also just so happens to be one of Warren Buffett’s largest holdings and one of the major reasons he is as wealthy as he is.
Coca Cola is a dividend king meaning it has increased its quarterly dividend for fifty or more consecutive years.
That’s pretty impressive! People might scoff at Coca Cola’s minimal gains, but the stock rarely has major collapses.
Another thing I like about Coca Cola is the stock is relatively cheap compared to others on this list. Coca Cola is the definition of a solid blue chip stock that will compound over decades of holding it in your portfolio.
Home Depot (NYSE: HD)
Are you seeing a pattern here? The Dow Jones holds some of the best blue chip stocks on the US markets. Home Depot is one of the kings of American retail. It is one of the largest retail brands in the world and has over 2,300 locations across North America.
It also pays a generous 2.58% annualized dividend yield and consistently raises it each quarter. The stock isn’t cheap, but starting a position in Home Depot will certainly pay dividends, literally, over the long-term.
Johnson & Johnson (NYSE: JNJ)
A literal giant in the pharmaceutical and consumer goods landscape, JNJ is one of the anchors of the US economy. It is a component of the Dow Jones and the exclusive S&P 100 index. It is the largest pharmaceutical company in America and one of the largest consumer goods brands as well.
You might recognize some of Johnson & Johnson’s products like: Tylenol, Band-aid, Benadryl, Motrin, Listerine, and Aveeno, just to name a few. Johnson & Johnson pays a 2.56% dividend yield and like Coca Cola, is also a dividend king.
Other Blue Chip Industries
There are blue chip stocks in nearly every industry. As I mentioned, big tech stocks are likely going to become the next generation of blue chip stocks. Companies like Apple, Microsoft (NASDAQ: MSFT), and Alphabet (NASDAQ: GOOGL).
Other industries with blue chips include the big American banks, energy stocks, and consumer goods companies. Even retail has some blue chips like the aforementioned Home Depot and of course Walmart (NYSE: WMT) and Amazon (NASDAQ: AMZN).
Conclusion: Blue Chip Stocks
So now you know the history behind why these companies are called blue chip stocks. We reviewed some of the pros and cons of investing in them, as well as providing a few examples. Are blue chip stocks for everyone? Absolutely not.
There will always be those investors who are interested in riskier plays that have the potential for a higher payout. But if you are looking for stable gainers that can compound through high paying dividends, look no further than blue chip stocks.