Companies represented by blue chip stocks are typically of high quality with a long history of stable earnings. The publicly traded shares often represent well-known name brands run by high quality management teams that often pay dividends to their shareholders.
Some long-term investors view these companies as being of lower risk when compared to newer fad stocks that have yet to prove themselves fiscally.
The bottom line is that blue chips stocks are typically a good investment. But how do you choose the best ones to invest in? Here are 3 steps you can use as a guide.
1. Find the Blue Chip Stocks
Although blue chip stocks usually share certain quantifications such as large market capitalization and dividend payouts, much of their status is derived from high qualifications which are slightly more intangible. Scanning for such companies based on a few simple numerical guidelines may not yield the desired list of blue chip stocks.
Instead, try looking for them in an index. An index is simply a basket of stocks with a commonality, merged, and displayed as one large combined price. An index could represent an entire exchange, a selection of small growth stocks, or income-generating blue chip stocks.
- Dow Jones Industrial Average: The New York Stock Exchange (NYSE) considers this index containing 30 large stocks to be of blue chip quality. They include such companies as Microsoft, American Express, and General Electric.
- S&P 500 Dividend Aristocrats: To be included in this prestigious dividend index, the company must have large capitalization, be of blue chip quality within the larger S&P 500 index, and have a history of increasing dividends for at least the past 25 years.
- Bridgeway Blue Chip 35 Index: Many other blue chip indexes and funds are available such as the BRLIX. Examining the holdings of these smaller indexes is one method to potentially uncover suitable blue chip stocks.
Picking blue chip stocks from an index is a wise strategy. Why? Prestigious indexes usually have high standards to be met. A panel has already reviewed the stock to ensure the blue chip status. Being included in an index will give the stock higher visibility in the stock market and increase its liquidity.
- Warning: Be careful that the panel reviewing companies for inclusion in their index have the same mentality of blue chip stocks as you do. For instance, BRLIX includes the companies Apple and Google which do not pay dividends and are still considered growth stocks by many despite the massive market capitalization.
2. Look at the Yields
Some indexes, such as the S&P 500 Dividend Aristocrats, call for a long history of increasing dividends. While this criteria is a good start, you will need to make sure that the yields are also stable. For instance, a company may trade at $100 and the dividend payout is $10 per share. 25 years later the share price is $500 and the dividend payout is $25. While the total payout has increased, the yield has dropped in half.
Certain stock market charting sites, like Big Charts, will visually display the historical dividend payout and the trailing dividend yield. Just make sure the total yield isn’t shrinking.
3. Learn to be a Beta-zoid
No, you do not need to attend a Star Trek convention to be a blue chip Beta-zoid. Beta is the measure of a stocks volatility when compared to the market. If you want lower risk, look to the beta as an investing strategy.
- A stock with a beta of 1 will move up and down in similar proportions to the market, as tracked by a major index.
- A stock with a low beta, below 1, will rise and fall with less volatility than the market.
- Stocks with a high beta, above 1, will move with higher volatility than the general market.
Small high-growth stocks will have higher betas from having higher speculative investment risk. You would expect blue chip stocks to have lower volatility since they are large high-quality companies with greater ability to weather rocky economic conditions. The downside to big size is that they often do not have the aggressive expansion potential as their smaller cap siblings.
A lower beta represents less risk. Especially if you are buying and holding (i.e. passive investing) while collecting decent dividends, you should look for a beta below 1.
Finding the perfect blue chip stock can take time and due diligence, but the payoffs are large. With careful research you should be able to find a moderately high yielding blue chip stock that pays increasing dividends in most economic conditions while giving back modest capital gains over many years of holding.