A blue chip stock is one that is recognized by investors as likely to withstand a changing economy.
“Blue chip” describes a stock investment in a large company with steady revenues and strong management. Most blue chip stocks are in well-established industries. While not immune to competition or changing tastes, these companies are expected to prosper well into the future.
There is no hard-and-fast definition of blue chip. However, most such stocks trade on the largest and best-known indexes of the market, such as the Dow Jones Industrial Average or the S&P 500 Index.
When investors talk about the stock market, blue chip thus becomes a way of denoting the performance of stocks most likely to increase in value steadily over long periods.
Long-term investors know that owning quality stocks is the bedrock of a serious investment portfolio. That means owning U.S. large-cap stocks that have proven track records of growing their businesses and creating shareholder value.
Often, the definition of shareholder value includes dividend payments, though some blue chip stocks might reinvest earnings instead.
Think of the major sectors of the economy — transportation, healthcare, manufacturing, technology and so on. Now try to think of the names of the three or four leaders in each subcategory, such as leading car makers, airlines, health insurers and industrial companies.
An investment professional would recognize the resulting list of firms as blue chip investments. Similar, most ordinary people would recognize the brand names associated with the corresponding products and services.
With brand power comes size. While there is no clear cut-off point, the majority of blue chip firms are very large, generating billions in revenue and millions in profits on a regular basis.
Occasionally, companies slip and lose market share. New companies create previously non-existent industries and become the new name brands everyone knows.
The takeaway for the investor is not to worry about what defines blue chip as much as understanding what is isn’t: small, unproven firms with relatively low earnings and past giants that have faded as brand names and no longer lead in their industry.
A portfolio built on blue chip stocks as a foundation is one that is likely to grow along with the economy. Adding smaller firms can create value for the investor, though the risks are higher. That’s small cap investing.
Similarly, betting on previous winners who have run aground is value investing. Neither, however, is blue chip investing.
MarketRiders, Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.