What is a ‘Blue Chip’
A blue chip is a nationally recognized, well-established, and financially sound company. Blue chips generally sell high-quality, widely accepted products and services. Blue chip companies are known to weather downturns and operate profitably in the face of adverse economic conditions, which helps to contribute to their long record of stable and reliable growth.
The name “blue chip” came about from the game of poker in which the blue chips have the highest value.
BREAKING DOWN ‘Blue Chip’
The term ‘blue chip’ was first used to describe high-priced stocks in 1923 when Oliver Gingold, an employee at Dow Jones, observed certain stocks trading at $200 or more per share. Poker players bet in blue, white, and red chips with the blue chips having more value than both red and white chips. Today, blue chip stocks don’t necessarily refer to stocks with a high price tag, but more accurately to stocks of high-quality companies that have withstood the test of time.
A blue chip company is a multinational firm that has been in operation for a number of years. Think companies like Coca-Cola, Disney, PepsiCo, Wal-Mart, General Electric, IBM, and McDonald’s which are dominant leaders in their respective industries. Blue chip companies have built a reputable brand over the years and the fact that they have survived multiple downturns in the economy makes them stable companies to have in a portfolio.
Conservative investors with a low risk profile or nearing retirement will usually go for blue chip stocks. These stocks are great for capital preservation and their consistent dividend payments not only provide income, but also protect the portfolio against inflation. In his book The Intelligent Investor, Benjamin Graham points out that conservative investors should look for companies that have consistently paid dividends for 20 years or more. The Dividend Aristocrat List published by Standard and Poor’s comprises of large cap blue chip companies from the S&P 500 that have increased dividends every year for the last 25 years.
Blue chip stocks are seen as a less volatile investments than owning shares in companies without blue chip status because blue chips have an institutional status in the economy. The stocks are highly liquid since they are frequently traded in the market by individual and institutional investors alike. Therefore, an investor who needs cash on a whim can confidently create a sell order for his stock knowing that there will always be a buyer on the other end of the transaction. Blue chip companies are also characterized as having little to no debt, large market capitalization, stable debt-to-equity ratio, and high return on equity (ROE) and return on assets (ROA). The solid balance sheet fundamentals coupled with high liquidity have earned all blue chip stocks the investment grade bond ratings.
An investor can track the performance of blue chip stocks through a blue-chip index, which can also be used as an indicator of industry or economy performance. Most publicly traded blue chip stocks are included in the Dow Jones Industrial Average (DJIA), one of the most popular blue-chip indices. Although changes made to the DJIA index are rare, an investor tracking blue chips should always monitor the DJIA to stay up to date with any changes made.