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 is most 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 Are Blue Chip Stocks?
How did they get their name? The term blue chip is 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 now widely used in other industries as well.
But let’s dive deeper into this market and see if blue chip stocks suit you.
Pros of Blue Chip Stocks
Anytime we recommend an investment, we must 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 friends, parents, or children.
That said, blue chips are generally seen as good investments in the stock market. So, is there any harm in owning the world’s most powerful and profitable companies?
After all, when choosing stocks, generally, we want to choose ones that are close to guaranteeing a profit in the future. So here are some reasons why these stocks make great investments for any portfolio!
Company Stability
There is no doubting the stability of a blue-chip company. However, something drastic would have to happen for these companies to leave the business.
Even in a market downturn like now, most blue chip stocks can hold their values somewhat.
The price will still fall, but generally less than growth or highly speculative stocks. Blue chip stocks comprise a major component of the Dow Jones and the S&P 500 indices.
They are rock-solid, profitable companies that usually have high cash flow and a strong industry moat.
Paying Dividends
Most blue chips will also pay you a quarterly dividend. This is a classic sign of a business with high cash flow using its profits to reward its shareholders.
Dividends are an excellent way to add cash flow to your portfolio and are one of the main sources of wealth for billionaire investors like Warren Buffett.
Collecting dividends can help compound your investments and 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 long-term stability to your holdings.
Cons of Blue Chip Stocks
As I mentioned, blue chip stocks aren’t for everyone! Blue chip stocks might not be your first choice if you are a 20-year-old investor looking to grow long-term wealth. Here are some negatives to investing in blue chip stocks.
They Are Boring
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. But, of course, we generally take this perspective when we have a short-term investing horizon in mind.
But it is true, and some investors like boring because boring investments are usually safe. Nobody says investing in blue chips is exciting, but over decades, they are about as steady as they come for growing your wealth.
Gains Are Minimal
That is also very true. However, blue chips have very little volatility. This is great for protecting your downside but also severely limits your upside. So, you generally won’t make 100% gains over the short-term with blue chip stocks.
These long-term compounders test the ‘time in the market’ saying. As a result, you won’t see many traders choosing blue chips as a scalp trade or even a day trade.
They Can Be Expensive
Not on multiple bases but on a stock price basis. Blue chip stocks tend to be priced at over $100 per share. While that doesn’t seem like much, it can be difficult for new investors to allocate much capital to these stocks.
Of course, you can buy fractional shares or an ETF, but it will cost you if you want to hold these blue chip stocks! You can also take a look at options on these more expensive stocks.
Options allow you to trade higher-priced stocks for less money. However, options aren’t as cut and dry as stocks.
Best Blue Chip Stocks
Ah, yes, the stock recommendations. Take these with a grain of salt because there is never a ‘best’ stock. When researching blue chip stocks, I look for profitability, cash flow, moat, and 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)
Can tech stocks be blue chips? Who says? Apple checks all the boxes: dividend, profitable, industry moat, and a ton of cash flow.
Many 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 Dow Jones component and the largest weighted component of the S&P 500 and the NASDAQ. So, 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. But, unfortunately, it also 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)
Do you see 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 quarterly. Admittedly, the stock isn’t cheap, but starting a position in Home Depot will pay dividends 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 Dow Jones and exclusive S&P 100 index component. It is the largest pharmaceutical company in America and one of the largest consumer goods brands.
You might recognize some of Johnson & Johnson’s products like Tylenol, Band-Aid, Benadryl, Motrin, Listerine, and Aveeno, to name a few. In addition, 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. But, as I mentioned, big tech stocks will likely 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 Home Depot, Walmart (NYSE: WMT), and Amazon (NASDAQ: AMZN).
Final Thoughts on Blue Chip Stocks
So now you know the history behind why these companies are called blue chip stocks. We reviewed some pros and cons of investing in them and provided a few examples. Are blue chip stocks for everyone? Not.
Investors will always be interested in riskier plays with 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.
