Blue-chip stocks are the ivy league of investment stocks. They are shares of companies known for steady cash flow, solid balance sheets, reliable business structure, and excellent performance history. And like coca-cola or Nestle, these underlying companies are household names that have stood the test of time.
Their excellent performance and track records over time make blue-chip stocks some of the most secured investments. They should form a part of your diversified portfolio to help balance the possible losses in market downturns.
Your portfolio would be incomplete without blue-chip stocks.
It's vital to have blue-chip stocks in your portfolio. But before we dive into that, let's have a quick overview of blue-chip stocks.
What Are Blue-chip Stocks?
Blue-chip stocks are shares of long-standing companies that are well established, big, financially stable, leaders in their sector, and well-known. Like blue-chips in poker games, from which the name is derived, blue-chip companies are highly valued.
They are known for strong financials, steady dividends, and cash flow – characteristics that long-term investors are looking for.
The benefits of having blue-chip stocks as part of your portfolio include steady dividend payout, dividend growth, lower volatility, and predictable growth trend.
Seasoned investors consider them to be relatively safer than other stocks. Hence, they will make a valuable addition to your portfolio, especially in times of market uncertainties.
However, it's vital that you pick the right blue-chip stocks as not all of them will meet the required expectations. The idea is to focus on the real valuation of the company and steer clear of overvalued stocks.
Don't be discouraged by the fact that blue-chip stocks aren't fast-growing. Be more concerned with the consistent gains over the long term plus the greater stability.
Although there are no set standard criteria as to which stocks are considered blue-chip, they possess some identifying characteristics that set them apart.
Blue-chip companies have the following in common:
- Stability: Blue-chips are typically decades old and have shown considerable earning consistency over that period.
- Consistency: Blue-chips that are also dividend stocks show consistent dividend payments over time. They also tend to grow dividends paid per share at a steady rate. Returns on capital as well as returns on equity are also consistent.
- Competitive advantage: Their reputation and cost efficiency due to size give them an edge. These companies can borrow money at a much lower cost than competitors because of their solid balance sheet and assets. Their products and services are high-quality and diversified across multiple geographic locations, which gives them resiliency.
- Benchmark Indices' Components: Blue chip companies are usually part of benchmark indices like The Dow Jones Industrial Average, the S&P 500, Nifty 50, Sensex, etc. Benchmark indices are a group of securities or stocks used in measuring how well or poorly other stocks or securities performed in the market.
Real-life examples of blue-chip stocks include Nestle, Coca-Cola, Proctor and Gamble, Shell, Mc Donald's, and Amazon. These companies are also on the Fortune 500 list.
Now that you have a firm grasp of what a blue-chip stock is, let's proceed with why it makes sense to have shares of profitable and well-recognized companies in your portfolio.
Why You Should Have Blue-chip Stocks in Your Portfolio
Blue-chip stocks should be a part of your well-diversified portfolio. Naturally, they are more expensive but are totally worth it in the long run. Here are some reasons why.
1. Safe Dividends
Your primary concern as a dividend investor is the safety of your dividends. That is, you continue to steadily receive your share of the company's earnings. Because if the company stops paying dividends, then you cease to be a dividend investor. Dividends are part of a company’s profit distributed to shareholders as quarterly payments.
Smaller companies and startups typically keep all their earnings for investing in further growth and will not pay dividends yet. However, they may start to pay dividends once they grow to a reasonable size and have fewer internal investment opportunities.
In contrast, blue-chip stocks have witnessed steadily growing and consistent dividend payouts over time. As an investor, you benefit from portfolio income no matter the daily fluctuations in the share price.
Another beauty of dividends is that they hedge against inflation since they represent income that is likely to increase as the general cost of living climbs.
Blue-chip companies have strong financial foundations, which makes your dividends safe. They earn the trust of investors by consistently paying and growing dividends. This is the primary goal of any investment and a great way to build wealth long term.
2. High Returns on Investment
Historically, blue-chip stocks have performed better than the general stock market, which averages 8% to 10% return. Blue-chip stocks can return up to 12% when you ideally reinvest your dividends. It's best you automatically reinvest your dividend and returns. Meaning that you'll earn interest on your interest, making your stock portfolio grow even faster.
3. Safe Harbor Stocks
Blue-chip stocks tend to be safe harbor stocks. They are less volatile than penny stocks and smaller companies' stocks and are also likely to rebound faster after a market downturn. Although they are not immune to losses when the broader market takes a hit, they won't disappoint you in the long run.
Blue-chip stocks are best suited to buy-and-hold. And if you hold on to them long enough, say decades, they always bring in high returns no matter the market fluctuations. These stocks are safe, and hardly do they go bankrupt. They offer an added measure of safety in a volatile market for your portfolio.
4. Brand Recognition
Blue-chip stocks are popular, recognizable brand names. This means you can get regular updates on the companies' progress through mainstream media. You'll be on top of your stock investments without putting in the extra effort to monitor the markets.
As an investor, you may get a kick from supporting your investment by, say-buying gas at a shell gas station or drinking Nestle bottled water.
5. Liquidity and Ease of Access
Because they are popular, blue-chip stocks are easy to buy and sell. You will appreciate this benefit more when you try to sell unpopular stocks. It can be frustrating trying to offload less-popular investment when their value starts to drop or when you want to release some of your equity.
Blue-chip stocks are some of the most liquid investments in the world. You can trade them at a moment's notice and through various brokers, fund managers, or online platforms.
Blue-chip companies are typically diversified along product lines, demographics and location. Take British Petroleum, for instance. It's an Oil and Gas company, but it also owns convenience stores in the US and gas stations. It also owns the Wild Bean Coffee company headquartered in the UK. Therefore, the company straddles the consumer and retail markets as well as the commodities market.
This shows that a blue-chip investment can offer as much diversification as investing in 3 or more small growth and value stocks. And it will only cost you one transaction fee. Diversification ensures the company is resilient and won't go out of business when one of its product lines or target market goes down.
7. Diversified Portfolio
When you invest in blue-chip companies, you secure a part of your portfolio against volatility. These companies will allow you to hedge against losses due to their excellent cost efficiencies. Even when the market witnesses a downturn, they will help you mitigate the losses due to their resilience. And historically, they are known to bounce back faster when the market recovers.
8. Availability of Investment Options
Investors can access blue-chip stocks in a variety of ways. You can buy the stocks directly, or you can get them through ETFs or investment funds. You can choose from a bouquet of investment options, including UK-based companies of the FTSE 100, the American S&P 500, or the Korean Exchange. The ETFs have the advantages of minimal transaction fees, allowing you to easily diversify your portfolio while keeping your cost down.
9. Strong Financial Fundamentals
Blue-chip companies ride on the wings of strong financial indices. Such companies have ideal debt-equity ratios, an efficient operating cycle, and excellent financials.
This gives you greater confidence knowing your investment portfolio has less volatility, lower downside risk, and the robustness to respond to unprecedented market events in a better way. These are some of the factors that make blue-chips preferred over other stocks in the general market.
Investors with a low-risk appetite are better off investing in blue-chip stocks. You want to earn decent gain without putting all your money at risk.
A blue-chip stock growth may not be exponential, but they offer more peace of mind for your investment than the regular stock.
How To Identify Blue-chip Stocks That Are Best Fit for Your Investment Portfolio:
So you are convinced that blue-chip stocks are the way to go for a sturdier investment portfolio. You understand that mutual funds and experienced investors prefer them due to their dominance in the financial markets and impressive track record.
While most large-cap companies' stocks are considered blue-chip, not all of them are. A company's size doesn't necessarily mean they are blue-chip. With the thousands of blue-chip stocks in the market, how do you go about selecting the right one that will suit your investment needs?
- Size: Its value indicates a company's size by the stock market- or market capitalization. Market capitalization is the value of a publicly-traded company's outstanding shares. It is the value you get by multiplying its total number of shares by the current market price.
Blue Chip stocks are typically huge, with a market capitalization in the ranges of $5 billion, $10 billion, or more. They also have large and steady revenue streams.
To select the best blue-chip stock to buy, start by considering large-cap companies that are dominant in their industries. With your investment preferences and the ideal composition of your portfolio in mind, first, identify the sectors you'd like to invest in and determine the best company stocks based on their market capitalization.
- Company Revenue: When you have identified the biggest companies based on capitalization in your preferred sector, the next step is to check out their revenue or income. Ideally, the companies you would want to invest in will have a larger market share in the sector they operate in and hence, higher revenues. Compare the revenues of the biggest companies in that sector and invest in the ones with the largest.
- Compare the Piotroski Score (F-Score): A company's financial strength is a vital criterion for considering its stocks as blue-chip. The go-to-tool for determining a company's financial strength is the Piotroski Score or f-score.
Created by accounting Professor Joseph Piotroski, the Piotroski Score combines 9 criteria to evaluate a firm's financial strength. These criteria include liquidity, profitability, operating efficiency, leverage, and source of funds.
A business with a high Piotroski score – 8 to 9 is financially strong and desirable from his analysis. A company with a score lower than 6 is considered to be in relatively good shape financially. Companies with scores lower than 3 are economically weak and should be avoided.
- Return on Equity (ROE) Return on Equity or ROE helps you identify companies with higher profitability as against shareholders' equity. It is a financial ratio that measures how well a company uses shareholders' funds to generate profit. A company with higher ROE means that they are more efficient when compared to their peers in the industry.
It helps to bear in mind that each industry or sector has its own acceptable ROE. While a high ROE is a good indicator of an ideal blue-chip stock, ensure you get ROE data from the past 5 years at least. A good ROE over that period means a solid blue-stock pick.
- Return on Assets (ROA): In the same way, Return on Equity is a measure of how efficiently a company uses shareholders' funds. Return on Assets or ROA identifies a company that uses its assets effectively to generate profit. It is the profitability of a business against its total assets less its debts.
The ability of a company to optimally utilize its resources while maintaining profitability is a good sign. It shows that the company is in capable hands and can survive any economic turbulence. This is the kind of blue-chip stock you'll want in your portfolio.
- Valuation of the Company (Intrinsic Value of a stock): A company's valuation or intrinsic value is not the same as its market capitalization. The market capitalization is based on the price you pay for the stock. It's utterly different from the value of the company.
Factors like demand and supply, social and political environment affect a company's price, amongst other economic factors.
Therefore, it would be counterproductive to judge a company based solely on its market capitalization. The true worth of a company is its market value.
When you buy an underpriced stock, you stand to profit on your investment since you are buying it at a price less than its actual value.
So when looking for blue-chip stocks to buy, pay close attention to the stock's intrinsic value rather than the current market price. Get a list of the top companies in the industries you wish to invest in and compare their inherent value to get a short-list of blue-chips stocks you want to buy.
Blue-chip stocks are a must-have in any investment portfolio. With solid balance sheets, a trusted business model, steady cash flows, and a history of increasing dividends, blue-chip stocks are some of the most secure stocks you can ever buy. Due to their historically strong performance and excellent track records, seasoned investors consider them a safe haven.
But blue-chip stocks can also go down when the broader market takes a hit. However, they are less volatile than smaller growth companies and usually recover first when the market bounces back.
You should consider blue-chip stocks as part of your buy and hold strategy. You are likely to earn stable returns over the long term. Blue-chip stocks can be added as part of a diversified portfolio together with lower-risk investments like bonds.
Investors with a low-risk appetite are better off investing in blue-chip stocks. You want to earn decent gain without putting all your money at risk. A blue-chip stock growth may not be exponential, but they offer more peace of mind for your investment than the regular stock.
And despite their much-touted safety and stability, it's best if you carry out your due diligence before buying any blue-chip stock. Do not just invest in a company because someone recommended them. No matter how solid the investment looks, take their suggestion and do your own research before committing your hard-earned cash.
Bernz JP is founder, writer, thinker, and digital marketing addict at Moneylogue (https://www.moneylogue.com/). He is passionate about self-development, personal finance, and the stock market. He believes that financial knowledge combined with self-discipline is the key to achieving financial freedom. An avid golfer and a 15 handicapper.