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What are blue-chip stocks?
Blue-chip stocks are large, well-established and financially-sound companies that have been operating for many years. With their dependable earnings, they often pay dividends to investors. These companies show steady growth in good times and bad and have emerged as leaders in their industries. Most, in fact, have become household names.
The moniker ‘blue chip’ comes from the game of poker, where chips with the colour blue are more valuable than others.
Characteristics of blue-chip stocks:
- Large market capitalisation: In general, blue-chip stocks have large market values of over US$10bn.
- Growth potential: Blue chips tend to have reliable financial performances and sustained earnings growth potential.
- Component stocks of market indices: Many blue chips are component stocks of major market indices such as the Dow Jones Industrial Average and S&P 500.
- Pay dividends: Blue chips are typically mature companies that no longer need to reinvest the bulk of their earnings in their businesses to fund growth. Many thus pay regular dividends, which is one reason for their popularity with investors.
Examples of blue-chip stocks
In the US, some blue-chip stocks are:
- American Express
- Procter & Gamble
- Cisco Systems
Pros and cons of investing in blue-chip stocks
Like other stocks, there are pros and cons of investing in blue chips.
- Stable, reliable earnings: Blue chips tend to have stable earnings. During an economic downturn, investors may turn to blue-chip stocks because of the perception that they won’t go out of business. Blue chips are also widely believed to be among the first to recover from a downturn.
- Record of attractive returns: Many blue chips have a history of delivering strong returns to investors over the long term.
- Low volatility: While there is always risk involved in investing, blue-chip stocks are generally considered less risky than smaller companies. They may not have the potential to double in value suddenly but they are also unlikely to lose most of their value overnight.
- Dividend payment: Blue chips often have cash surpluses which they regularly pay out to investors as dividends.
- Moderate growth potential: Because blue chips are already so large and successful, they may have limited room for further growth.
- Low returns: Blue chips may be low-risk investments but their returns are normally low as well. Blue chips often lag the index in a bullish market.
- Price: Because blue-chip companies are often large and very popular with investors, their share prices are generally much higher than growth stocks, making them less affordable.
- Competition: Blue chips are not invulnerable to risks. Big corporations can be slow to respond to changing consumer behaviours, industry trends and technologies. New entrants or start-ups often make them a target for disruption. Think of national flag carriers and the threat posed by budget airlines or banks and their shake-up by fintech disruptors.
Frequently Asked Questions
Thoroughly research a blue-chip company as you would for any other stock. Start by going through the company’s earnings and dividend-payment records for several years, through both boom and bust cycles.
Choose companies with low debts and good credit positions since such companies have a strong financial position to face adverse situations.
Analyse parameters like returns on equity (ROE) and returns on assets (ROA).
Compare several high-quality stocks and decide which ones to invest in based on your stock evaluations and personal investment goals.
Diversify your portfolio to different sectors, including finance, manufacturing, consumer, utilities, commodities and resources to reduce risks.
You can also gain exposure to blue chips through mutual funds that invest in or ETFs that track blue chips. Such funds provide an entry into blue chips without their hefty costs. Blue-chip ETFs track blue-chip indices or major stock-exchange indices that include blue-chip stocks, such as the Dow Jones Industrial Average, S&P 500 and Nasdaq-100.
No. Blue chips may be lower-risk investments but they are still vulnerable to market risks as well as company-specific risks. A market sell-off can lead to a sell-off of blue-chip stocks. Companies in highly-cyclical industries such as tourism or with high fixed costs such as manufacturing and airlines can face credit-default risks during a prolonged economic recession.
Not all, although most do. Check a company’s dividend-payment record over the years before you invest.
Blue-chip stocks are generally considered good investments for people looking to build wealth in a steady, relatively low-risk manner, as they focus on dividends. Dividends supply you with a steady stream of income for funding purposes such as retirement.
Blue chips, however, aren’t all that appealing to those trying to accumulate capital quickly or those with a higher risk tolerance. Such investors will opt for growth stocks as these are expected to grow faster than the market. Growth stocks generally do not pay dividends but reinvest their earnings in the business to accelerate growth. When investors invest in growth stocks, they anticipate that they will benefit from capital appreciation when they eventually sell off their shares.
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