A blue chip stock is a large, financially-sound, nationally-recognized and well-established business that trades on public markets. Blue chip companies usually sell high-quality and broadly-used products and services. They are known for their long-term track records of stable and reliable growth, helping them operate profitably regardless of current economic conditions. Learn more about blue chip stocks.
Blue-chip stocks tend to be among the most stable, best-performing stocks available to retail investors. These stocks allow investors to buy shares in stable companies that have a large market capitalization.
However, the “price” that investors pay for that stability is muted (but not nonexistent) organic growth. With that said, blue-chip stocks deserve a place in every portfolio. In this article, we’ll explain why there’s never a bad time for investors to buy the blue chips.
A Goldilocks Combination of Growth and Value
Should you buy growth stocks? Should you buy value stocks? This becomes a circular argument among many investors. And when investors turn to the financial press, they find that analysts and advisors will offer different opinions. The truth is that over the years, there’s a case to be made for both.
However, the downside to having a portfolio that is overweight growth stocks or overweight value stocks is that it is likely to underperform at different times. That’s the benefit of blue-chip stocks.
What are blue chip stocks? They offer the best attributes of growth and value stocks. And this combination provides a smoothing effect for portfolios. These stocks may not outperform pure growth stocks during robust bull markets, but they are also likely to be among your “less bad” performers during market corrections.
Mature Companies in Mature Sectors
What is a blue chip company? One reason that drives the consistent performance of blue chip stocks is that many of them are in defensive industries. Defensive stocks are stocks of companies with a proven track record. These companies have products and services remain in demand no matter what is going on in the economy. An example of this would be Johnson & Johnson (NYSE:JNJ). The company’s personal care products are in demand by consumers. Another example is Coca-Cola (NYSE:KO) which is a favorite of no less an authority than Warren Buffett.
Both companies are in extremely competitive sectors. However, these companies have loyal consumers that are willing to seek out their brands at the expense of their competitors. This gives these companies pricing power.
Is Amazon a blue chip stock? Learn more.
Rock Solid Balance Sheets
That pricing power leads directly into another shared trait of blue chip stocks. These companies have strong fundamentals that make them some of the highest value stocks. For example, many companies have pricing power means that allows them to pass along increased producer costs to the consumer. This means that the companies are more likely to retain their operating margins, which will typically translate to more stable earnings.
This pricing power also means these companies generate positive free cash flow (FCF) which they can use to reward shareholders. In many cases this is done in the form of a dividend. A dividend payment is a way for shareholders to “collect rent” on the shares they own. In addition to paying dividends, many of these companies will issue stock repurchase (stock buyback) programs which is another way to make the stock price more attractive and encourage other investors. Learn more about how to find blue chip dividend stocks.
Reinvesting Dividends and the Power of Compounding
In addition to receiving dividends, many blue chip stocks give investors the ability to reinvest their dividends. Reinvesting dividends is a solid strategy that can boost total return and deliver the benefit of compounding.
For example, if you own $1,000 shares of KO stock in June 2022, you would be in line to collect $5,520 in annual dividends. By reinvesting those dividends you would buy 22.66 new shares without having had to add any of your own money.
But there’s an even bigger benefit. Since Coca-Cola pays its dividend quarterly, you would buy 5.66 shares per quarter, compounding your dividend payment for the next quarter and so on and so on. Here’s an example not including fractional shares:
Quarter 1 = 1.38 x 1005/4 =346,72
Quarter 2 = 1.38 x 1010/4 = 348.45
Quarter 3 = 1.38 x 1015/4 = 350.17
Quarter 4 = 1.38 x 1020/4 = 351.90
And keep in mind that many of these companies increase their dividends every year. Rising dividends increase the benefits of compounding.
Other Benefits of Blue-Chip Stocks
Consistent performance, solid balance sheets, and the opportunity to collect dividends (and benefit from the power of compounding) should be enough to convince you that blue chip stocks have a place in your portfolio. But if you’re still not convinced, here are a couple of additional reasons why blue chip stocks have a place in every portfolio.
First, investors should consider the benefit of diversification. Blue chip stocks are a way for growth investors to add a value component. They can also give value investors some exposure to growth. But diversification also means broadening your sector exposure. One way to do this is to find mutual funds and exchange traded funds that specialize in blue chip stocks.
Many investors rely on blue chip funds to provide sector diversification. However, quality blue chip stock can do some of that work as well. For example, a stock like British Petroleum (NYSE:BP) provides exposure to the oil and gas sector as well as the commodities market.
And speaking of ETFs, another benefit of blue chip stocks is that investors can find an ETF that specializes in blue chip stocks. This is a great option for investors who don’t want to purchase individual stocks or simply want a more set it and forget it option for this percentage of their portfolio.
Another way for investors to gain exposure to blue chip stocks is through an index fund that benchmarks the Dow Jones Industrial Average (DJIA). That’s because many Dow stocks have blue chip status.
Learn more about how to invest in blue chip stocks.
Blue Chip Stocks Have Something to Offer Every Investor
Are blue-chip stocks a good investment? Investors with a high risk tolerance may choose to invest in small-cap or mid cap companies. The stocks of these companies provide the opportunity for outsized future growth. However, these securities also add the possibility for an outsized risk to the downside.
For those investors blue chip stocks can be a viable alternative. Having a few of these stocks in your portfolio, even if they occupy a very small percentage, can help offset the gut-churning volatility that can affect every investor’s actual risk tolerance.
Conversely, more conservative investors need not stick to fixed income, low growth assets. Buying blue chip stocks can offer the opportunity for capital gains that may, in many cases, outpace the rate of inflation which is a concern with fixed-income investments. And since many blue chip stocks pay dividends and rising dividends at that, investors have another avenue for collecting income from these high-quality stocks.