The stock market rises and falls day after day on the performance of blue chip stocks. Blue chip stocks comprise the 30 largest companies that make up the Dow Jones Industrial Average. They are the focus of many fund managers and the core holdings of many retirement plans. There are many reasons that investors are attracted to blue chip stocks. Let’s take a deeper look at the advantages and disadvantages of investing in a blue chip stock.
What is a blue chip stock anyway?
A blue chip company is a well established nationally recognized company. Blue chip companies are some of the largest companies in The United States. They are the pillars of the American economic system. The performance of blue chip companies dictates the market’s performance on a daily basis. These companies tend to be far more stable in their operating performance. They have solid earnings and are financially sound.
Many people wonder where the blue chip name was derived from. The blue chip name actually comes from poker. Blue chips have the highest value of any of the chips in poker games. This makes perfect sense because blue chip companies have the largest market caps in the Dow Jones and S&P 500. Companies like Exxon, Walmart, and Apple have market caps well above $200 billion dollars. They are bellwethers of economic activity in the United States.
Why should you invest in a blue chip company?
Investors love blue chip stocks for their stability. Since blue chips stocks tend to be larger companies, they are less volatile than mid and small cap stocks. Blue chip companies are safer investments because they have the balance sheets to survive economic downturns. Thus they fall less than other stocks during recessionary environments. Institutions and investors pour money into blue chip stocks during difficult times because they are safer defensive companies.
Another advantage of a blue chip stock is the dividends. Blue chip companies are maturing companies with tons of cash on their balance sheet. They have to deploy this cash somewhere so they often pay back a lot of this cash back to shareholders via dividend distributions. Blue chips are none for giving consistent dividend increases to shareholders. Fixed income investors love these stocks for that reason.
What is the disadvantage of a blue chip stock?
The downside of blue chip stocks is that they often under perform small and mid cap stocks during economic booms. Since these companies are so large, they grow at much slower rates than other stocks. The growth component is sacrificed for the safety of the investment. The old adage is correct: No risk, no reward.
How do you feel about blue chip stocks? Do you like the safety or do you prefer to invest in riskier assets?