Beginner investors often feel more comfortable investing in names they know when they first get their feet wet in the stock market. In market lingo, these large, well-established companies are often blue chip stocks, representing companies that rank as the leader or among the leaders within their respective industries.
But what exactly are blue chip companies, should you invest in them, and how do you go about finding the opportunities that offer the highest dividend payments?
What Are Blue Chip Stocks?
As with many investing terms, the term “blue chip” started as a gambling term. In poker, the color of each poker chip represents its dollar value. In many casinos, the blue chip is the most valuable, representing the largest bet a player can make at the poker table with a single chip.
Blue chip stocks are somewhat similar. These are perceived as the highest quality stocks on the market, representing companies with a long-standing track record of success.
Blue chips generally trade with a high price and are often household names, but they’re far from being the same across the board. These darlings of Wall Street represent companies in just about every sector of the market.
Blue Chip Market Caps
One of the biggest debates surrounding how to define blue chips has to do with their market capitalization, or the total value of the company based on the current share price. This is because size isn’t necessarily a determining factor in what makes a company a leader.
Sure, these stocks aren’t going to be penny stocks or small-cap companies, but they aren’t always the largest of large-cap stocks either. The generally accepted base value of a blue chip player is $5 billion, but most companies in the category trade well above the $100 billion mark.
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Characteristics of Blue Chip Companies
With such a liquid definition in terms of market value, how exactly can you determine if a stock you’re interested in is a blue chip? There are a few signs to look for:
- Inclusion In Benchmark Indexes. Most blue chip stocks are so large that they play a big role in overall market movement. These stocks are generally included in the market indexes that show how well or poorly the overall market is doing. For example, if the stock isn’t included in the Dow Jones Industrial Average, S&P 500 index, or the Nasdaq 100 index, there’s a strong chance it’s not a blue chip stock.
- Liquidity. Blue chips stocks are highly regarded, resulting in high demand among the investing community. This also results in high levels of liquidity, meaning that there are lots of people buying and selling shares, so you’ll have no trouble entering or exiting a position.
- Low Volatility. Blue chips represent companies that are the cream of the crop in their respective markets. These companies have long histories of leadership within their markets — often decades or even centuries. They tend to generate relatively predictable growth including long-term, sustained increases in both revenue and earnings. As a result, they don’t experience nearly as much volatility as lesser-known companies that don’t come with the same history of success.
- Among the Top 3. One great gauge of whether a company you’re considering investing in is a blue chip is to simply look at its leadership in its market. This can be done by looking into market share. For example, if you’re interested in investing in blue chip semiconductor companies, simply type “top semiconductor companies by market share” into the search bar of your favorite search engine. The top three companies on the list are likely to be blue chips.
- Household Name. Finally, most blue chip stocks represent companies with household names. If you recognize the company as a leader in its industry, there’s a strong chance that you’re looking at a blue chip player.
Examples of Blue Chip Stocks
There are several blue chip stocks on the market today, each offering up a unique, yet relatively safe investment opportunity. Here’s a list of blue chips you’ll most likely recognize:
- Apple (NASDAQ: AAPL). As the king of the smartphone industry and developer of the iPhone, Apple has become one of the most recognizable companies in the world. The company currently has a market value of nearly $2.4 billion, and tens of millions of shares of the company trade hands during the average trading session.
- Coca-Cola (NYSE: KO). If you’re looking for a soft drink, juice, or even water at your local convenience store, there’s a strong chance you’ll make your way to the Coca-Cola cooler. The company behind the household name is worth more than $239 billion, and more than 14 million shares trade hands every day.
- Walmart (NYSE: WMT). Walmart is the top dog in the retail industry with 10,526 stores spread across 24 countries around the world. The company is quickly growing toward an overall market value of $400 billion, and there’s no shortage of investor activity in the stock with more than 7 million shares traded during the average trading session.
- International Business Machines (NYSE: IBM). International Business Machines is a global technology conglomerate that offers solutions to industries ranging from consumer services to health care and everything in between. The company currently has a value of more than $122 billion and experiences average trade volume of around 5 million shares per session.
- Johnson & Johnson (NYSE: JNJ). Johnson & Johnson is a highly diversified health care company, offering a long line of products including medicine and everyday hygiene products with a number of recognizable brand names. The company has a value of more than $439 billion, and its shares trade hands more than 6 million times during the average trading session.
- McDonald’s (NYSE: MCD). Finally, McDonald’s is a global leader in the fast-food sector, representing a brand that’s prominently displayed on its more than 39,000 restaurants around the world. Today, the company is worth more than $171 billion, with more than 2 million shares of the stock trading hands during the average trading session.
Why Blue Chips Are Generally Safe Bets
Blue chip stocks are often regarded as the safest low-risk equity investments on the market, and for good reason. There’s no way to become one other than building a track record of dominance in your market.
These companies offer stability during market downturns. While they may fall in value during bear markets and market corrections, the declines experienced on these high-quality stocks will generally be less severe than other stocks without the same track record or clout.
Keep in mind that while blue chips are some of the safest bets on the stock market, there’s no such thing as an investment in any stock that doesn’t come without risk. At one point, Enron was considered a blue chip stock before the company’s scandal came to light, resulting in the loss of $74 billion that was ultimately absorbed by shareholders. As such, even with blue chips, research is important.
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Do All Blue Chip Stocks Pay High Dividend Yields?
One major reason investors choose blue chips is for strong dividend payouts. After all, some of the top blue chip stocks also represent some of the best opportunities in another category, dividend stocks.
While many blue chip companies have attractive dividends, they are by no means a requirement to be considered a blue chip stock.
Many people who invest in this category are specifically looking for strong income opportunities by investing in blue chips with high dividends. If that’s your goal, it’s important not to just blindly invest in a company because it represents a blue chip opportunity.
Instead, do a bit of research into both the company’s dividend history over the past five years and its expected dividends in the future. Doing so will tell you if the company has a strong history of providing compelling dividends and if the expectation is that this activity will continue.
Are High Dividends Always a Good Thing?
Before you go looking for the companies that are paying the highest dividends, it’s important to understand that there are pros and cons to this type of income. Dividends are often paid to investors to the detriment of the company’s stability and ability to maintain a competitive stance within their market.
Dividends are a percentage of the company’s profits that are returned to investors through quarterly or annual payments. If a company doesn’t retain enough of its earnings to continue innovating, building out infrastructure, and taking part in other (often expensive) processes associated with expansion, it may fall from its throne as more competitive players take the lead.
For example, Amazon.com is definitively a blue chip. The company is one of the largest in the world and a clear leader in the e-commerce and cloud computing industries. You may find it upsetting that the company hasn’t yet made a single dividend payment to investors.
But its investors aren’t missing out! Amazon’s growth has been the result of reinvesting its profits into itself, building out the infrastructure that allows for shipping speeds that other companies could only dream of competing with.
At the same time, the company’s clout as the leader gives it the ability to buy and sell products cheaper, generating meaningful margins while offering the most competitive prices on the market for many of its goods.
How to Find Blue Chips That Pay High Dividends
As mentioned above, not all blue chip stocks come with dividends. Going deeper, not all blue chips that come with dividend payments come with the types of payments that are going to turn heads.
So, how do you go about finding blue chip opportunities that pay high dividends?
One of the best ways is to look for opportunities on the S&P 500 Dividend Aristocrats market index. The index was first launched in 2005 and is designed to track the top-notch dividend opportunities within the S&P 500.
The companies listed on the S&P 500 Dividend Aristocrats index have a history of increasing their dividend payments annually over the past 25 consecutive years. All stocks listed represent large-cap companies, many of which are blue chip players.
To find opportunities, simply look for household names on the list. Once you find a name that you find interesting, it’s time to further your research to see whether the investment fits within your investment strategy.
Key Stats to Look for Before Investing in Blue Chip Stocks
Although there’s no way to tell what’s going to happen in the future, with a bit of research, you can determine whether you’re paying the right price for a blue chip stock and whether it’s likely to grow ahead.
Here are some of the key stats you should review before investing your first dollar:
According to many experts, including Warren Buffett, valuation is one of the most important factors to consider before making an investment. In fact, there’s an entire style of investing, known as value investing, that puts valuation metrics above all when choosing stocks to buy. Unsurprisingly, this investing style has historically done well, even outperforming the growth investing style over the long run.
Due to their high demand and stature as leaders of their respective markets, blue chip stocks often trade with outlandish prices, but if you can find a blue chip diamond in the rough that’s trading at a discount, there’s a strong probability you’ll make money in the long run by investing in it.
When determining whether a stock is trading above, below, or at fair market value, you’ll need to use valuation metrics like the price-to-earnings (P/E) ratio and the price-to-sales (P/S) ratio. By comparing these ratios to market averages, you’ll end up with a clear picture of the discount — or lack thereof — that you’ll be getting when you buy a stock.
Some blue chips ultimately fail to innovate, leading to competitors taking them over in the long run. One of the best ways to determine whether a company is likely to hold its position as a leader is to look into the company’s growth over the past five years, specifically mapping out annual revenue and earnings growth percentages over the years.
If you notice a trend of continued and robust growth, you’re likely on the right path. Conversely, if you realize that growth has been slowing, a plateau may be on the horizon, giving competitors an opportunity to gain market share.
Sure, there are blue chips out there that don’t offer dividends, but for most investors who are looking for stability in their portfolio, income is an important factor.
If you’re looking at blue chip stocks for stability and income, you’ll want to pay close attention to both the dividend history and expectations of dividends moving forward to determine whether the stock is a good fit for your portfolio.
Intellectual property (IP) is the lifeblood of most leading companies. Patents and trademarks keep competitors at bay because they know they will be sued into oblivion if they compete using the same technologies or even concepts.
However, many forms of intellectual property expire, and when they do, competitors are free to dive in. This is often a major risk in the pharmaceuticals industry — one where exclusivity periods on intellectual property are limited.
Before making an investment, look into the company’s intellectual property and make sure that no key patents or other IP offering periods of exclusivity are expected to expire soon.
Who Should Invest in Blue Chip Stocks?
Due to the stability blue chips offer, these stocks should be part of just about everyone’s investment strategy, but for most investors, they shouldn’t make up the majority of your portfolio.
Younger Investors (35 and Under)
Young investors age 35 and under have plenty of time to recover should declines happen and can afford a higher risk appetite as a result. While blue chips should be used to balance out risk within the portfolio, they shouldn’t represent more than 20% of your stock holdings.
The other 80% of your stock allocation can be geared toward higher-return opportunities like small-cap value stocks, growth stocks, and emerging markets investments.
Sure, these opportunities are riskier than their blue chip counterparts, but they also offer the highest potential returns — and with time to recover from any downturns, the risks are outweighed by the rewards.
Middle-Aged Investors (36 to 55)
As you break into middle age, it’s time to start thinking more strategically about asset allocation, adding more fixed-income to your portfolio for safety and adjusting your stock holdings toward more stable securities.
While you’ll still want some access to higher-risk plays like small-cap value, growth, and emerging markets stocks, you’ll want to limit these investments, giving more weight to blue chip and dividend stocks that offer some growth potential, but also generate income while adding a level of stability.
Retirees and Those Near Retirement (56+)
Congratulations, your golden years are just around the corner. Now it’s time to make sure the retirement nest egg you’ve worked so hard to build is safe and ready for you when you need it.
At this point, you will want to start allocating the majority of your investments to fixed-income assets. While these assets aren’t known for growth, they are prized for stability, minimizing your chances of significant losses as you near retirement or during your retirement years.
For many retirees, stocks should represent a small portion of your portfolio, and within that stock allocation, you should refrain from investing in high-risk plays. Instead, focus your investments on stable blue chip stocks and dividend plays in order to reduce any drawdown risk should markets take a tumble.
Consider Investing in Blue Chip-Focused ETFs
If you’re not well-versed in investing and don’t feel comfortable choosing your own stocks, or you simply don’t have time for the research involved in doing so, there’s no shame in looking to exchange-traded funds (ETFs) for opportunities.
There are plenty of blue chip funds that only invest in companies with blue chip status.
By investing in these funds, you’ll be investing in diversified portfolios built of some of the most stable companies in the world, representing industry leaders across a wide range of sectors and regions.
If you’re looking into blue chips for safety, why not consider expanding that safety with an investment in such a diversified group of companies? Blue chip funds give you the ability to do just that.
Blue chip stocks are the comfortable choice. These are the investments you make in companies that you know and love, and which are known for generating stable returns. However, a stock portfolio completely allocated to these investments would be a mistake for most investors.
When making investment decisions, you should practice diversification and asset allocation strategies that align with your goals and tolerance for risk.
Moreover, there’s a common misconception that any blue chip stock represents a solid investment opportunity. That couldn’t be further from the truth. Before investing in any company — blue chip or otherwise — make sure to do your research and get a good understanding of exactly what you’re buying before you invest.