What Are Blue Chip Stocks And How To Invest In Them?
What Are Blue Chip Stocks?
Done right, the activity of investing in the stock markets has very little to do with gambling. But the truth is that the term blue-chip stocks are a derivative of poker. Thus, it can be understood that the concept has a deep relationship with the world of betting. An investment is a bet, not like those made in poker, but in a certain sense, it is.
Although there is no formal definition for blue-chip stocks, these companies are recognized as being valuable, stable, and well-established. These companies are characterized by being highly recognized – often American companies – in their industry, and investors count on them because of their reliability.
In addition to all this, we have to show you everything you need to know about blue-chip stocks.
What Makes A Stock A Blue Chip?
The term blue chip originates from the high-stakes games of poker. In poker, playing chips (chips) represent different dollar values depending on their color. While the white chips are the least valuable, perhaps representing only $1 per chip, the red chips are next in line at $5. Blue chips (blue chips) mean that the chip itself has the highest value of the bet on the table. This term was therefore taken from the game of poker and adapted for use in stock market terminology.
In this sense, we can think of blue-chip stocks as the kind of stocks you want your friends to know you bought on the stock market. If you buy, for example, a share of Microsoft or Apple, some of the typical blue-chip stocks, you want your friends to know that you have invested in these companies. Therefore, blue-chip companies give a very good first impression, as they are highly supported, stable, have a high prospect of durability, and are reliable.
Companies issuing blue-chip stocks have proven themselves in both good times and bad, and these stocks have a history of strong performance. Those stocks that are considered blue-chip stocks have the following things in common:
Dominant Companies And Leaders In Their Sectors
They are companies that lead their sectors and produce the dominant goods and services within the industry. In some cases, these companies are themselves important monopolies with great market power or part of some oligopolistic sector that prevents the development of more aggressive competition against the goods that these companies produce.
While some small growth companies are ideal choices for younger investors looking for the next big thing, blue-chip stocks have a long history and are well known by the public. In this sense, this type of stock is the ideal option for the most conservative investors, since everyone knows it and in general terms, it is believed that in the long term they will perform well.
They Are Well Established Companies
There are several well-known and well-capitalized companies that are not yet well established enough to be considered blue chips. These companies are immersed in investments in new technologies. For example, Facebook, now Meta, had some 1.84 billion daily active users in 2020, making it one of the best-known companies on the planet. Facebook also reached a market capitalization of over $1.05 trillion as of July 28, 2021, which means it is a well-capitalized company. However, Facebook hasn’t been around until 2004, so it’s not a well-established enough company to be considered a blue-chip stock. Since it is not a well-established company,
Blue-chip stocks are viewed as safer investments than other stocks because they have long histories of strength and resilience.
During periods of recession, a blue-chip company is often less impacted by adverse economic conditions. For example, Coca-Cola is a blue-chip company that might not suffer from a recession because so many people choose its products every day, regardless of economic conditions. Blue-chip companies are known for having very stable growth rates. So its stock has less volatility than other companies that are not well established. However, the shares of any company can be hit hard and lose their blue-chip status.
They Are Well Capitalized Companies
A blue-chip company must also be a well-capitalized firm in at least two senses. It must first be large enough to be able to withstand a sharp market decline, as highlighted above. The market capitalization of a blue-chip company is generally in the billions of dollars. Second, a company must have a high enough credit rating to qualify as a blue-chip stock. In particular, downgrading a company’s debt to junk bond status is enough to disqualify it from being considered a blue-chip stock.
Some companies meet the criteria of being well-known and well-established firms but are not well-capitalized enough to be considered blue chips. These are usually old firms that have fallen on hard times. In 2020, several well-known and well-established companies in the retail industry fell into this unfortunate category. Sears and JCPenney were both well-known companies in the United States with well-established businesses that had been going on for the space of a century. However, they were not well capitalized to be considered blue-chip companies due to several years of decline.
The Role Of Stock Indices
A blue-chip stock is the stock of a blue-chip company. If a stock is considered a blue-chip, it is generally the stock of a leading company in a sector or one of the best companies in a certain sector. Typically, a blue-chip stock is a component of a renowned market index and fund that averages the performance of the markets, such as the S&P 500 index in the United States or the Nasdaq 100. It could be argued that stock The US must be a member of the S&P 500 index to be considered a blue-chip stock.
Generally, a stock is considered a blue-chip if it falls within the Dow Jones Industrial Average companies. For example, Apple gained its status as a blue-chip company when it joined the Dow Jones in 2015. The Dow Jones Industrial Average consists of thirty of the blue-chip companies headquartered in the United States.
Advantages And Disadvantages Of Investing In Blue Chip Companies
There are different positions on blue-chip stocks and the companies behind them. Experts have highlighted the advantages of investing in this type of stock and the respective disadvantages. Although many authors are convinced that there are more advantages than disadvantages, we try to provide a neutral perspective on this below:
- Strong financial performance
- They have the potential for regular and consistent dividends.
- Low risk of falls in the market.
- They are less volatile
- Consistent performance over the long term
- They are well-regulated and governed companies.
Now Let’s See The Disadvantages:
- Low returns on investment
- Scarce Dividend Yields
- Slow capital appreciation
- They cannot beat the most important market indices in their returns
- It may be an overly conservative investment choice, which may limit the search for new and better investment opportunities.
If you look at the points made above, you will naturally find that most downsides are counterarguments against potential upsides (eg low downside risk versus slow capital appreciation). These are not the only pros and cons, but these might give you an idea of why financial gurus recommend or discourage investing in blue-chip companies.
Why Should You Invest In Shares Of Blue Chip Companies?
This question is answered in the previous section where the advantages of this type of stock are evident, but keep in mind some additional points that you could consider about why blue-chip companies are better than their smaller peers such as mid-cap companies, small caps, and penny stocks, among others.
Access To Diversified Businesses
Diversification across different asset classes or sectors is very important to any investor. Similarly, an investor should look at those companies that have a broad and diversified business model. Take the case of companies like Unilever, a major player in fast-moving consumer goods – they are found in such varied fields of the retail sector as food, beverages, personal care and hygiene, cosmetics, among others.
On the other hand, in the case of the company Tech Mahindra, this information technology services consulting company, is more focused on one sector within its industry. This doesn’t necessarily imply that Tech Mahindra is a bad choice – it’s just one example of non-blue chip companies’ lack of diversification, which makes them potentially riskier businesses. Similarly, some companies have a regional or local presence, while blue-chip companies have a national and international presence.
They Have Strong Brands
If you look at the products you use in your day today, you will find that there are several dozen brands. For example, there are shampoo brands such as Pantene (P&G), Clinic All Clear, Abbot, Apple, Microsoft, among others. The same happens with noodle brands such as Maggie (Nestlé), Top Ramen (Nissin Foods), Yippie Noodles (ITC) among others.
These brands are worth billions of dollars and bring a lot of revenue and profit to their respective companies. When you invest in blue-chip stocks, you invest in these high-impact selling brands that generate millions of dollars each month. Some of these brands’ products will continue to be sold every day regardless of whether the economy is doing well or not.
Resistance And Resilience In The Face Of Economic Crises
This point has already been emphasized as one of the key characteristics of blue-chip stocks. But remember that this only applies to blue-chip stocks that are in defensive sectors of the economy (such as pharmaceuticals, fast-moving consumer goods, health care, food, energy).
Why is it like this? Some sectors serve basic consumption that corresponds to essential needs of the economy, which do not fall significantly during economic crises. For example, during the economic crisis of 2008, most FMCG stocks (which initially fell) gradually began to move higher against general market trends. Why? Because investors and analysts had more faith in FMCG and pharmaceutical stocks compared to stocks in other sectors.
Low Level Of Debt And Leverage
Leverage is the strategy of borrowing money to generate higher returns on a business. It’s something good? Yes, depending on whether the returns provided by the business are higher than the cost of the leverage. If not, the company will be paying high debt service for its income and this will erode its balance sheet.
In simple terms it’s like taking on too much debt on a credit card, only to find that your credit card payments start to exceed your income level. Although debt is necessary for any business, it is also true that too much debt can erode profits and render a company insolvent.
The beauty of blue-chip stocks and companies is their strong capital base and balance sheet. Most of them do not require borrowing since they have strong promoters as well as strong reserves and ample cash flows that allow them to be aware of the present and future capital needs.
In cases where it is necessary to resort to debt, these companies can raise funds by issuing bonds and acquiring credit at preferential rates from banks. Blue chips have the advantage of being able to borrow at a much lower cost than smaller or newer companies. Most banks and financial institutions are comfortable and much more willing to lend money to blue-chip companies.
Less Probability Of Fraud And Deception
Big corporations like Enron and Satyam have been some of the biggest financial frauds in history. However, these types of fraud are much less likely in large companies, although they cannot be completely ruled out. In some cases, for example, when LIC Housing Finance reported that there was a case of blackmail and fraud in the company, the theme was expanded in the news and took the stock to its lowest point, but then the stock recovered and gave good results. returns when control systems were established. Since most blue-chip corporations are well-governed this is less likely and even if a problem does occur it can be quickly controlled and minimized before it impacts the entire organization.
Future Plans And Vision
Blue-chip companies have a strong management team who have a solid understanding of the business as well as the commitment the company has made going forward to achieve its vision.
For example, Infosys, an Indian blue-chip, has been a model example of a vision for information technology firms in India.
These companies have also proven their managerial maturity and capabilities because they have a great talented team that trains them for a succession of plans to reach new goals each year.
It is something that is taken for granted. Blue-chip companies and stocks are highly investor-friendly in several ways:
They consistently pay dividends (high dividends if business performance is excellent).
They maintain their value over time and can increase it considerably.
The risk of falls in the stock market is much lower than in the case of other companies.
Examples Of Blue Chip Companies And Stocks
According to the Motley Fool portal, some of the most important blue chips, as of February 4, 2022, are the following companies:
Johnson & Johnson
Procter & Gamble
United Health Group
How To Invest In Blue Chip Stocks
One of the easiest ways to invest in blue-chip stocks is to buy shares of ETFs like those that follow the S&P500, BlackRock‘s IVV ETF may be a good option for this. ETFs offer a diversified way to invest in the stocks of a sector of the market. Given that, as is the case with the IVV or the State Street DIA ETF, which follows the Dow Jones Industrial Average, these funds follow the behavior of multiple market shares, by investing in each of them you will be investing in several companies at the same time of solid history and a good performance in the stock market.
Another option is to buy individual shares (or fractions of shares) of blue-chip companies. By investing in this way you will find yourself with a higher risk in the market but you will be able to consolidate a much more interesting portfolio and if you choose your options well, the returns can be highly significant.
Whether you want to buy shares of ETFs or shares and fractions of blue-chip companies, the easiest way to do this is to look for a reliable broker like eToro or Robinhood, other options include companies like Flink, which offers direct access to the stock market of New York from the Mexican market or local brokerage houses depending on the country you are in. In the Colombian case, the Tyba company of the trustee CrediCorp Capital could be one of the options to consider to access the international blue-chip market.