Blue chip stocks are shares of companies that are large, stable and reliably profitable ('blue chip companies').
Blue chip companies often pay dividends, as opposed to growth companies which are more likely to reinvest income into their own businesses. Growth companies are companies that generate growth at a rate much faster than the overall economy.
There is no hard and fast definition of what makes a stock a blue chip but generally the largest stocks in an index are referred to as “blue chips”.
These companies are typically familiar and have established reputations. They tend to pay regular dividends and many people appear to already own these shares.
Traditionally they have been seen as safe long-term investments because they are usually so familiar to investors (and invariably everyone!).
That’s not to say the list of these stocks won’t change over time. We have found that over time new players emerge and old ones fade away.
The opposite of blue chip stocks are generally referred to as penny stocks - shares in small companies with relatively low share prices often listed on smaller exchanges.
Where did the name ‘blue chip’ come from?
The name derives from poker, where the blue chips used in betting have the highest value. The phrase dates back to the 1890s in the United States.
What are some Australian examples of blue chip stocks?
The Big Four banks - Commonwealth, Westpac, ANZ and NAB - are good examples. So, too, are Telstra and BHP as well as the retail giants Woolworths and Wesfarmers.
Standard & Poor’s ASX 20 Index tracks the performance of 20 Australian companies listed on the ASX that are among those with the greatest combined share value, also known market capitalisation. All of these companies are generally considered blue chip.
The ASX 50 may include many more blue chips, depending on how you apply the criteria.
What are some international examples?
In the US, blue chips shares are generally understood to be shares in companies such as Microsoft, Boeing, Bank of America, Amazon, ExxonMobil and DowDuPont.
The Dow Jones Industrial Average tracks 30 of the largest stocks in the US stock market - perhaps the bluest group you will find.
In Britain, blue chip shares are generally understood to be shares in companies such as British American Tobacco, BP, GlaxoSmithKline, Vodafone and Unilever. The London Stock Exchange’s FTSE 100 Index tracks the biggest British companies by market capitalisation but not all of these may be considered blue chip.
What are some advantages of buying blue chip stocks?
- They generally have a proven track record.
These are shares in companies that have stood the test of time. They have earned reputations as industry leaders and typically have advantages of scale.
- They generally pay regular dividends.
Many people are looking to earn regular income from the money returned to shareholders by companies. Younger, promising companies may have yet to post profits or are reinvesting more of their profits to continue expanding. These, unlike blue chips, may be unable to afford such returns.
What are some disadvantages?
- They may have fewer opportunities for growth.
While they may be less volatile, it cuts both ways; there is less chance they will fall steeply but also less chance they will really take off. Blue chips have already been rewarded by the market and are widely seen as a good bet.
Being larger companies, the chances they will increase profits dramatically are slimmer.
- They may offer less diversification.
Some people over-invest in blue chips because of their attractiveness. They cost more, which leaves less money to buy other types of shares.
And the really blue chips in Australia tend to be concentrated in a few sectors: financial services, mining, energy and supermarkets. Downturns in these sectors may leave a heavy blue-chip investor exposed to greater losses in the short-term.
How do you invest in blue chip stocks?
You can invest directly by buying shares in individual companies. Or you can use an exchange traded fund that tracks the performance of a group of blue chip companies by investing in each.
Or you can get an exposure by investing in the Spaceship Index Portfolio, a collection of the world’s largest 200 companies by market capitalisation.