What are blue chip stocks? (and are they a viable strategy in the new world?)

So, you saved up a little money, your friend’s started calling you Rich Uncle Pennybags (that’s the guy from Monopoly, to save you the Google search to confirm what you’re thinking), and you’re trying to figure out how to turn your little money into a little more money. The words “blue-chip stocks” popped into your head for some reason, and you want to know if they’ll work for you.

Sound about right?

So what are blue-chip stocks anyway?

Blue chip stocks are shares of ownership in huge, very well-established companies that have been in business for a long time and have built large, reliable revenue streams.

Many are in industries that are extremely difficult or impossible to break into. They’re the companies whose founder’s grandchildren (who have never worked in their lives) still sit on the Forbes 400 list of wealthiest Americans.

These companies are the behemoths. The giants of American industry.
They’re also companies that investors love because the risks of them going broke are so low that, if they did go broke, everybody else would be screwed, too.

Some people also consider other companies to be blue-chips, but we haven’t included all of them here. Some, like Ford, we don’t think are big enough (plus we’ve talked about them in other articles), while others, like Berkshire Hathaway, are way too expensive ($323,275 per share).

We’ve also excluded some companies, like British American Tobacco, because we aren’t tone deaf and the entire tobacco industry is probably going to zero anyway after it kills all its customers.

As for the companies we did include, and true blue-chip stocks more generally, you may not be able to tell it from the chart above, but blue-chips are usually pretty steady. These companies, being so well-established, aren’t usually subjected to the same violent swings as the rest of the stock market.

But, this year (2020) is different, because, well, everything is different this year.

To be honest, when listing stock picks, I didn’t expect to see any of them up over 50% — I also didn’t think I’d have to order vegetables by mail or wear gloves and a mask to fill my car up with gas.

But, setting aside the anomalies like this year or 2008 or 2000 or 1987 or 1979 (maybe these years aren’t so rare...), blue-chip stocks are pretty steady companies. They don’t usually make big gains for investors, but can typically be counted on to return a few percent per year.

A GOOD blue-chip stock might also pay a dividend of an additional couple percent.

What makes a stock a blue-chip?

There is no strict definition or set criteria that determines which stocks are blue-chips. There’s not a “blue-chip club” with certificates that hang in the den’s of the founders’ grandkids. Put plainly, these are just big companies — really, really big companies; usually some of the biggest companies around by market cap — that investors perceive as very well-established and reliable.

For example, while both are large companies, you won’t hear many advisors suggest that Netflix or Tesla be considered blue-chip stocks. Most won’t even consider companies like Facebook among the blue-chip set. Blue chip companies aren’t new — they’ve been around for awhile, they’ve carved out market share for themselves, and established themselves as part of the market firmament.

They’re usually through their “disruption” phase and firm in their “sit back and cash checks” phase of development.

So what’s important about blue-chip stocks?

There isn’t really much that’s important about blue-chip stocks — they’re just large, well-established companies. And, they’re popular because they’re popular.

Huh?

People invest in blue-chip stocks because LOTS of people invest in blue-chip stocks. Sort of the self fulfilling prophecy of investing if you will.

Because these companies are so huge and so established and so popular, they’re held in millions of investor portfolios and thousands of funds around the world — everything from index funds to mutual funds and pension funds to sovereign wealth funds own shares in these companies.

And, because these stocks are so widely held, it’s very rare for any precipitous drop in price to occur because no group of people so large would ever decide to sell all at the same time.

But, other than their size and perceived stability, there’s nothing set about blue-chip companies. They come from all different areas and industries. Some have been around more than a century, while others are just 25 or 30 years old (but typically no younger than that).

If you’re thinking about investing in blue-chip stocks, here are some things that you can consider to help you decide which to invest in:

Market cap

Blue chip companies are very valuable, with huge market capitalizations (value owned by shareholders). The bigger the market cap, the more valuable the company and the more unlikely the stock price is to collapse.

Time in business

Most of these companies have been around for decades. Some are still innovative, but most have established their market share and are focused on maintaining their business or growing incrementally. They’re not disrupting markets.

Stability

Look at volatility in stock price over the past 10 years. Most blue-chips (except for this year) are pretty steady, but make sure you’re willing to deal with the volatility.

Dividends

Blue chips are better if they pay dividends, even though their dividend rates are usually pretty low because stock prices are so high (dividend yield = dividend payment / stock price, so high stock price = lower yield).

And yet, for all their stability, there’s still money to be made investing in these companies—even at their high prices—thanks to their reliable revenue and established market share.

These companies also typically aren’t controversial. You don’t usually see their founders tweeting things like “Funding secured.” Sure, these companies may be in the news. After all, they’re huge employers and economic bellwethers. You likely won’t see them make headlines because they’re getting fined or executives are going to prison.

Is investing in blue-chips a viable strategy?

Even in today’s world of disruption and innovation, investing in blue-chip stocks is still an extremely viable investing strategy. Granted, investing in blue-chip stocks isn’t very sexy (but you can wear a cool cardigan while you check stock prices in the Wall Street Journal over your morning bowl of raisin bran),  these companies are usually considered very "safe" and will typically provide average returns of a few percent each year.

But, blue-chip stocks probably won’t give you returns that beat the market... except for this year, when a huge portion of the stock market’s total gains are due to just a handful of companies (some of which are named above).

And, because these stocks are so widely held, they’re relatively stable. When every index fund, every growth fund, and every pension fund in America is invested in a stock, that means that there are millions of dollars flowing into those stocks everyday and every week as fund investors make more contributions and fund managers invest their cash.

With that kind of money flowing into these stocks, it takes a lot to reverse the tide and push prices considerably lower.

How to invest in blue-chip stocks

We aren’t going to spend a lot of time on this, because the process is super simple (and because we’ve discussed it in great detail in other articles).

To invest in blue-chip stocks, all you need to do is open a brokerage account. Just visit ETrade, TD Ameritrade, or another online brokerage company that you like, and open an account. You can fund your account by transferring money from your bank account. Then, look up the stock you want to buy, and invest. Boom. It's that simple to get your slice of the blue chip pie.

If you aren’t sure which one to buy, research each company, ready analyst recommendations, and make your picks. To protect yourself from too much downside risk if the price of just one company goes down, consider diversifying your holdings by buying shares of multiple companies.

Note: This is pretty similar to what index funds do automatically, so if you want even more diversification, you might just consider investing in index funds instead.

Pros & cons of blue-chip stock investing

Pros

• Companies are huge, well-established, and relatively “safe,” so the risk of bankruptcy is low
• Blue chip companies usually have the best financing terms available, so their cost of capital is low which means the odds of them being overwhelmed by debt are small
• Companies are often vertically integrated to control their means of production and distribution, reducing costs and sheltering their revenue streams
• These stocks are very easy to buy through any brokerage platform
• Investing is cheap, with many platforms charging no commissions on trades in blue-chip stocks

Cons

• Investing in individual companies offers less diversification than investing in funds that have dozens or hundreds of holdings
• The upside from investing in these stocks isn’t usually very big because they can’t be bought for cheap
• Dividend rates aren’t great (some pay no dividends at all)
• Companies are subject to big market moves if overall economic activity drops off
• Blue chips can face significant regulatory exposure due to things like antitrust laws, FTC suits, or SEC actions

Alternatives to blue-chip investing

Blue chip investing is definitely a viable strategy in today’s climate, but it’s not for everyone. If you want to consider some other ways to invest your millions, here are a few:

• Index funds - They’re big, they’re broad, they’re diversified, and they’re cheap
• Real estate - Tangible assets offer great downside protection, plus unique tax benefits
• Real estate crowdfunding - Buy little pieces of a lot of deals with potentially more upside
• Or just investing in other stocks - dividend stocks, value stocks, penny stocks, or all the above

Have other investing ideas or questions about blue-chip stocks? Hit us up in the comments, and tell us what we forgot.