Blue chip stocks are shares of companies that are large, stable and reliably profitable.
They often pay dividends, as opposed to growth companies which are more likely to reinvest income into their own businesses.
There is no hard and fast definition of what makes a stock a blue chip but typically the largest stocks in an index are referred to as “blue chips”.
The companies are generally familiar and have established reputations. They tend to pay regular dividends. Many people already own these shares.
Traditionally they have been seen as safe long-term investments because they are so familiar.
That’s not to say the list of these stocks won’t change over time. New players emerge, old ones fade away.
The opposite of blue chip stocks would be 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 considered blue chip.
The ASX 50 would include many more blue chips, depending on how you apply the criteria.
What are some international examples?
In the US, blue chips shares are in companies such as Microsoft, Boeing, Bank of America, Amazon, Exxon Mobil and Dow Du Pont.
The Dow Jones Industrial Average tracks 30 of the largest stocks in the US stock market - the bluest group you will find.
In Britain, they include companies such as British American Tobacco, BP, GlaxoSmithKline, Vodafone and Unilever. The London Stock Exchange’s FTSE 100 Index tracks the biggest players but not all of these may be considered blue chip.
What are some advantages of buying blue chip stocks?
- They 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 often 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, would 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.
Many super funds will have large holdings of blue chips.