Introduction

There are many different investment categories people can choose to invest in and each of those has its benefits and drawbacks. While there are hundreds of publicly-traded companies that most of us have never heard of, blue-chip stocks allow people to put their money in enterprises they know well. The companies that issue blue-chip stocks are often manufacturers of products that most of us use every single day. Additionally, the signs of these companies are often visible in city centres and main streets, giving people a feeling that they know these companies well. In this article, we’ll explore whether or not these familiar firms also make for good investments and we’ll guide you through the process of finding and evaluating blue-chip stocks.

What Are Blue-Chip Stocks?

Blue-chip stocks are stocks issued by large, well-established companies that has a proven track record of financial success. In many cases, the companies in this category of stocks are household names that you are likely to be familiar with. Among more cautious investors, blue-chip stocks are popular because of their stable returns on investment over time. Currently, there is no definitive list of blue-chip stocks, but stocks that are considered to be “blue-chips’’ have the following things in common: 

Track record – Most blue-chips have been around for decades and are considered to be reliable investments, owing to the fact that they have solid long-term track records of stable growth. Blue-chips are especially popular among risk-averse investors as they are known to perform, relatively, well during market downturns.

Large-cap – Blue-chip stocks are large-caps, meaning that they have a big market capitalization. The market capitalization is the value of all of a company’s outstanding shares. To be considered a large-cap, the market capitalization of a company has to be over $10 billion.Industry leaders – Having been around for decades, blue-chip companies are normally leaders in their industry or sector. Blue-chips usually have a large moat, meaning that it’s difficult for competitors to compete with them. As a result, they can continue to grow and maintain their status as industry leaders. 

Dividends – Fast-growing companies with smaller market caps usually need to re-invest the money they make into their growth. In contrast, blue-chips are already well-established and often choose to share profits with their shareholders in the form of dividends. 

Inclusion in index – The major market indexes are full of blue-chip companies, making it relatively easy for investors to buy exchange-traded funds (ETFs) with exposure to blue-chips. The most reputable indexes that consist mainly of blue-chips are the Dow Jones Industrial Average, S&P 500, and the tech-heavy Nasdaq 100.

For many, especially long-term, investors, blue-chip stocks are the cornerstone of their portfolio. Their low volatility, steady performance, and regular dividend payments make them reliable anchors.  Below we’ll look at the advantages of investing in blue-chips a little closer: We’ll take a more in-depth look at the benefits of investing in blue-chip stocks in the sections below:

#1 Proven Track Record

Blue-chip companies have usually been around for decades, during which they’ve weathered all types of storms. This track record of surviving, and sometimes thriving, during economic downturns makes them more reliable than newer, smaller companies with a shorter track record. The iconic U.S. company General Mills, for example, was founded in 1866. Some of the most notable events the company survived are the Great Depression and the Great Financial Crisis.  Resiliency like this, in combination with decades of data on financial performance and stock market returns, makes investors feel confident about the future of a company. A proven track record of stability is especially important to more risk-averse or older investors. The chart below depicts the performance of General Mill’s share price between 1984 and 2021: General Mill’s share price performance between 1984 and 2021. Source: Yahoo Finance

#2 Dividends

Given their steady performance throughout the decades, blue-chip companies usually have solid and reliable cash flows. Since blue-chips are already large, well-established organizations they don’t need to re-invest all of the money back into the company for growth. Instead, they can afford to share their profits with the company’s shareholders. They do so by rewarding shareholders with a dividend payment, usually every quarter. Reliable and steady cash flows allow these companies to offer investors a relatively high dividend yield. This ratio shows how much a company pays in dividends annually as a percentage of its stock price.  In addition to regular payments, many blue-chips also regularly increase their dividend payment. If an S&P 500 company has managed to increase its dividend for 25 consecutive years in a row, it joins the S&P 500 Dividend Aristocrats index. It comes as no surprise that this index is full of blue-chip companies, such as 3M, AT&T, and IBM.  In the image below we can see General Mill’s annual dividend increases between 2008 and 2016: The increase of General Mill’s dividend from 2008 to 2016. Source: harvestingdividends.com

#3 Low Volatility

Companies with a small market cap tend to be quite volatile investments since they are relatively illiquid. Blue-chips, on the other hand, are very liquid and investors can easily buy or sell large numbers of shares without influencing the share price. The steady, reliable financial results and resiliency during economic distress cause many investors to flee towards blue-chips in difficult times. In addition, many blue-chip companies are active in sectors that are relatively unharmed during an economic crisis due to their non-discretionary nature.  Beta volatility indicator A good way to judge a stock’s volatility is by looking at its beta, a volatility indicator. A low beta indicates low volatility and a beta above one indicates that a stock is more volatile than the general market. General Mills has a beta of 0.5, indicating that the company’s stock is about half as volatile as the market. This is rather a rule than an exception for blue-chip companies, making them attractive investments for investors wary of high volatility.  Below we can see General Mill’s performance versus the S&P 500 during the March 2020 stock market crash:  GIS versus the S&P 500 during the March 2020 stock crash. Source: Yahoo Finance

Where To Find Blue-Chip Companies

There are blue-chip companies in virtually every sector and they’re easy to find as they’re normally (one of the) leaders in a particular industry. The Dow Jones Industrial Average is known as a “blue-chip” index as it’s composed of the biggest companies in the United States. You might be familiar with many of these enterprises as blue-chips often make products that we use daily. This familiarity is an additional reason why blue-chips are so popular among retail investors.  A few examples of U.S. Blue-chip companies are:

Boeing (BA);Pfizer (PFE);Microsoft (MSFT);General Electric (GE);AT&T (T);Intel (INTC).

The composition of the Dow Jones changes regularly, but most of the U.S. blue-chip companies in the picture below have been included in the Dow Jones Industrial Average since the index started: Europe’s most well-known blue-chip index is the Euro Stoxx 50 [PDF], comprising Europe’s 50 largest publicly traded companies. A few examples of European Blue-chip companies are:

ASML(ASML);SAP (SAP);Airbus (AIR);L’oréal (OR);Allianz (ALV).

The overview below shows us the top 10 Euro Stoxx 50 components:     Top 10 components Euro Stoxx 50. Source: stoxx.com A few other important blue-chip indexes outside of the U.S. and Europe are:

The Nikkei Stock Average (Japan);The SSE 50 A Shares Index (China);The S&P/ASX 20 Index (Australia);The S&P/TSX 60 Index (Canada).

How To Invest In Blue-Chips

There are different ways you can choose to invest in blue-chip stocks. Whereas active investors might choose to purchase individual stocks, more passive investors would probably prefer to invest in an ETF that tracks a blue-chip index. 

#1 Individual Stocks

Since individual blue-chip stocks are easily accessible it isn’t hard to create a portfolio full of high-quality blue-chip stocks. Investors often choose to invest this way in an attempt to beat the average market return.  Dividend investors might prefer individual stocks as it allows them to choose stocks with the highest yields and best track record on dividend increases. On the downside, actively choosing and buying individual stocks will require more time and research.

#2 Funds

Alternatively, investors can choose to invest in an ETF or mutual fund. Whereas mutual funds are actively managed, ETFs simply follow an index. Many popular blue-chip ETFs track one of the indexes mentioned earlier in this article. The iShares Dow Jones ETF, for example, tracks the Dow Jones Industrial average and thus allows investors to invest in a “basket” of blue-chips with one purchase. The advantages of investing in an ETF are the automatic diversification and the low cost compared to mutual funds.  A few other examples of popular blue-chip ETFs are:

Vanguard S&P 500 ETF;iShares Core S&P 500 ETF;Schwab U.S. Large-Cap ETF.

Mutual funds can be an interesting option for people who want their investments to be actively managed. Although 60% of mutual funds underperformed the S&P 500 [PDF] in 2020, there are still funds that manage to beat the market. One example is Fidelity’s Blue Chip Growth fund with a 30% average annual return over 5 years.  Two other popular blue-chip mutual funds are:

T. Rowe Price Blue Chip Growth Fund;Robeco U.S. Large Cap Equities.

Note: To buy blue-chip stocks or funds, you’ll need to have a broker. A few popular platforms that are suitable for beginners and offer blue-chip stocks and ETFs include: ❖ Revolut; ❖ Robinhood (U.S. citizens); ❖ Wealthsimple (Canadian citizens).

Downsides of Investing in Blue-Chips

The stability and low volatility of blue-chip stocks appeal to many investors, but some, especially young and risk-hungry investors, tend to stay away from blue-chip stocks for a couple of reasons:

#1 Average Returns

As shown in our guide on dividend investing, many dividend-paying blue-chip stocks manage to outperform the average market return. Even though this is true, investing in blue-chips generally doesn’t offer you the potential of exceptional share price appreciation as the companies already have a large market cap. For this reason, many young and risk-hungry investors looking for high returns turn to small and medium-sized companies that can still grow substantially. Especially investors under 25 years of age tend to take on more risk, according to a Business Insider article.  These young investors are often attracted to the stock market by stories about spectacular short-term returns, as we’ve seen during the “meme stock’’ saga [PDF]. Blue-chip stocks tend to be more popular among long-term and older investors nearing retirement.

#2 Blue-chips Are Not a Guarantee

Blue-chip companies generally perform better during tough economic times, but they are not immune to them. Whether it’s due to an economic recession or a disruptor in the industry, blue-chips stocks don’t always remain blue chips. In a worst-case scenario, they might even disappear and be replaced by (a more innovative) competitor. A good example of this vulnerability to disruption is Kodak, a former digital photography company, and leader in its industry. It was widely regarded as a safe, blue-chip company, but due to competitive pressures and lack of innovation, the company eventually had to declare bankruptcy. A few notable examples of other failed blue-chip companies are:

Lehman Brothers;Enron;WorldCom.

The chart below shows us the collapse of Lehman Brother’s share price: Lehman Brothers’ share price between 2006 and 2008. Source: ResearchGate

Conclusion

Blue-chip stocks, on the whole, are popular investments due to their proven long-term track record of financial stability and performance. The share prices of these companies have often grown steadily for decades and most of them pay relatively high, and often increasing, dividends.  Additionally, their low volatility makes them suitable cornerstones of investment portfolios, helping investors to weather difficult market conditions. Given their prominence in most of the major stock market indexes, blue-chips are relatively easy to find and invest in. Investors can choose between individual stocks, funds, or a combination of the two. Some of the largest ETFs and Mutual funds around are full of blue-chips, making investing in blue-chips passively accessible to many.  There are, however, a few downsides investors have to keep in mind before buying blue-chips. A common reason not to invest in blue-chips is the fear of missing out on exceptional returns. Furthermore, blue-chips, like any other investment, are not a guarantee. There are many examples of blue-chip companies that failed and cost investors a lot of money.

They’re “large-cap” companies and often pay (increasing) dividends, explaining their appeal to dividend investors. Moreover, they are normally included in major market indexes, such as the S&P 500 and the Dow Jones Industrial Average. Additionally, blue-chips are very popular among dividend investors because these large enterprises can afford to share a substantial part of their profits with shareholders. Furthermore, they often increase their dividends on an annual basis and sometimes use excess cash to buy back shares. Moreover, the S&P 500 Dividend Aristocrats is an index constituted by 25 blue-chips that have increased their dividends for at least 25 consecutive years. A few other indexes that have many blue-chip stocks in them are the S&P 500, the Nasdaq 100, the Russell 1000, the Euro Stoxx 50 (Europe) and the Nikkei Stock Average (Japan).