shutterstock

There are many different theories or compendiums of advice for would-be investors. One of the most consistent has been that if you want to have the best returns, with steady, 'reliable' growth, invest in the most well-known, and highest-capitalized companies. These companies are called "Blue Chip" stocks. 

What Is a Blue Chip Stock? 

As many theories as there are for 'successful' investing, there are names for various types of investments. Blue Chip stocks, legend has it, are called that because the 'blue chips' held the highest value in games of poker. 

There is no definitive list of 'Blue Chip' stocks, though the genius of Charles Henry Dow and Edward Jones, who together formed Dow Jones & Co., which created the Dow Jones Industrial Average, has been considered the most reliable. 

The DJIA, or Dow, as it is known, is an average of 30 large publicly-owned stocks' performance throughout a trading day. 

Those 30 publicly-traded stocks are considered Blue Chip stocks by investors. In addition to being the stocks composing the DJIA, the 30 companies are considered as the strongest U.S. companies with the best reputations for growth. 

To name a few: Alphabet  (GOOGL - Get Report) , which owns Google, Amazon (AMZN - Get Report) , 3M  (MMM - Get Report) , American Express (AXP - Get Report)  and Apple (AAPL - Get Report)  . 

The companies comprising the DJIA have changed, but those that are listed are considered large, stable, and financially sound or well-capitalized. 

But that's not all that makes them Blue Chip.

To be considered a Blue Chip, a company must be have a large capitalization, growth history, be a component of a market index - not just the DJIA - and, generally, pay dividends, though not all do. 

The size and value of a company is measured as its market capitalization. Its growth history is usually impressive, with capitalization of $10 billion or more, and it will be a part of a major market index like the S&P 500, the Nasdaq 100, or a combination of one or more. 

And, although not all Blue Chip stocks pay dividends, most do, which also suggests they no longer have a great need to reinvest in their own company for it to grow. 

Why Invest in Blue Chip Stocks?

One reason many advisers recommend investors look at Blue Chip stocks is because of their reputation for having stable earnings. 

Companies with stable earnings over an observable period are seen as reliable investments. If a company has stable earnings, management appears to have found a formula that leads to company stability. 

Stable, reliable earnings also suggest similar returns for your portfolio. 

As previously noted, not all Blue Chip stocks pay dividends. But most do. Owning stable earning stocks that pay dividends boosts morale of investors, because in addition to the returns from stock value appreciation with the stable earnings, investors get paid something 'extra' for investing in the company. 

For instance, a company that paid a 20% dividend on stock that had already appreciated in value works as a clear incentive to investors. 

Another reason advisers recommend Blue Chips is that their history of stability is also an indication of strong financial support. 

Stability also indicates the company's financial footing is sound, not overly burdened by debt, with financial ratios such as debt-to-equity intact and within prescribed 'safe' limits, and the company has an efficient operating cycle. Such stability tends to protect the stock from severe volatility, limiting downside risk based on economic fundamentals.

Such stability is also good to help you maintain a diversified portfolio including a means to reduce your overall risk profile, allowing you to invest in stocks with greater risk knowing there are reliable, stable, less volatile and risky stocks in your portfolio. Blue Chips tend to have multiple revenue-producing divisions and diversified business lines that help them reduce potential corporate risk from operational failures or just losses. 

Most Blue Chip companies also have strong brand presence, such as shampoos or soda, cellphones or software or other products frequently seen and purchased by consumers. Blue Chip companies have a slight competitive advantage because of name recognition, and cost efficiency leading to strong earnings growth, franchise value, goodwill or distribution. 

What Are the Pros and Cons of Blue Chip Stocks?

Pros: 

  • Stability: Blue Chip stocks sometimes do fail, or crash, like others, but far less frequently. A classic example is Coca-Cola (KO - Get Report) , which made an initial public offering in 1919 of shares on the New York Stock Exchange for $40 a share. If you had bought a single share at $40 after the IPO, which crashed to $19 because of the 'Sugar Crisis,' and hung onto it, it would be worth more than $15 million with dividends invested, based on calculations from a 2012 proxy statement by the company itself.
  • Strong financial performance
  • Potential for regular dividends
  • Lower downside risk
  • Less volatile
  • Steady long term returns
  • Well regulated and governed

Cons: 

  • Blue Chips lose favor on the DJIA. The stocks considered Blue Chips have changed as the economy shifts, with some cutting dividends and others, like General Electric Co (GE - Get Report) . and General Motors (GM - Get Report) being removed from the index as stronger, more stable stocks took their place. General Electric was the last original member of the DJIA. It was, like most Blue Chips, a household name. But its sector wasn't growing, so Walgreens Boots Alliance (WBA - Get Report) took its place in 2018. Stocks that were once common household names, like Kodak (KODK - Get Report) , Xerox (XRX - Get Report) , and Chrysler are no longer even considered Blue Chips.
  • Blue Chip stocks can lag the market index in a bull market, suffer from poor management practices or scandals, and even lose market share to smaller companies. 
  • Because Blue Chip stocks are, by definition, stable, they aren't likely to 'beat the market' in terms of growth. As Blue Chips tend to be the ones driving stock averages and indexes, they aren't likely to stray much in terms of return from the averages. 
  • If you're a young investor, you may want instead to invest in companies that, rather than paying dividends, invest in their own growth and increased stock value. Younger investors are more likely to want a growth stock to build wealth than a steady, stable stock. 
  • Most potential good news is built into a Blue Chip's stock price. Bad news can therefore jolt investors and damage the share price that exists because of perceived stability.
  • Low, though steady, returns
  • Poor dividend yield
  • Cannot beat the market
  • May be conservative in terms of exploring more opportunities, diversifying in products or industries.

Examples of Blue Chip Stocks

Here are some examples of Blue Chip stocks currently attracting long-term investors. It is by no means a definitive list, but in addition to seeing the names of companies whose products you probably use in everyday life, you'll also see where the company's market capitalization was as of March 31, 2019, based on the number of shares outstanding at that time.

Following the company's name is its stock symbol, so you can look at its performance and other details yourself as often as you like. This list is meant neither as investment advice nor endorsement, it is merely a factual portrayal of the listed companies' status in terms of market capitalization at that time.

First up is Microsoft (MSFT - Get Report) , the computer software company that only came into shareholder existence in with an Initial Public Offering in 1986 with shares priced at $20 each. Microsoft had a market capitalization of $904.86 billion at the time of this list's creation.

Next, comes Apple Inc., (AAPL - Get Report) which first came into shareholder existence before Microsoft , with an IPO for priced at $22 a share, in 1980. The personal computer company that has since branched into several other products had a market capitalization at the time of this list's creation of $895.67 billion.

Third is Amazon  (AMZN - Get Report) , or AMZN as it is known to investors. Amazon started attracting investors with its IPO in 1997 offering shares at $16 each. The company had a market capitalization at the time of the creation of this list of $874.71 billion.

Another familiar and popular name for the past decade or more, Google Inc., which is now a division of umbrella company Alphabet, came onto the market with an IPO as recently as 2004. The company first offered shares under the symbol GOOG at $85 each. The symbol GOOG now represents the Alphabet's Class C shares (GOOG - Get Report) . Alphabet's Class A shares trade under the symbol GOOGL, and had a market capitalization at the compiling of this list of $818.16 billion.

Berkshire Hathaway (BRK.A - Get Report) is next in terms of market capitalization at the time of the compiling of this list. BRK.A, as the A shares of the stock are known, traded before Warren Buffett even began buying any at $19 a share in 1962. Buffett took the company over in 1964, which is from when the company uses its historical comparisons, and had a market capitalization at the time of this list's compilation of $493.75 billion.

Alibaba Group (BABA - Get Report) is next. The Chinese e-commerce company had the largest IPO on record in the U.S., debuting in 2014 at $68 per share and raising $21.8 billion from it. At the time of compilation of this list, BABA, as it is known, had a market capitalization of $472.94 billion.

A more familiar company to most Americans of a certain age, Johnson & Johnson,  (JNJ - Get Report) went public with an IPO in 1944 at $37.50 a share. The healthcare products company has since traded as JNJ, and had a market capitalization at the time of the compiling of this list of $372.23 billion.

JP Morgan Chase & Co (JPM - Get Report) traces its history to its founding in 1799 of The Bank of Manhattan by Aaron Burr. The combination of major banks throughout the years has resulted in JP Morgan Chase & Co, traded as JPM, having a market capitalization of $345 billion at the time of the compilation of this list.

Similarly, Exxon Mobil (XOM - Get Report) , the current and largest direct descendant of John D. Rockefeller's Standard Oil Co. of Ohio from 1870, formed as the result of a merger between Exxon, which was the Standard Oil Co. of New Jersey, and Mobil, which had begun as Standard Oil of New York. The pair merged in 1998, trading as XOM, and had a market capitalization at the time of the compilation of this list of $342.17 billion.

The last of the top 10 in terms of market capitalization as of the compilation of this list is Visa (V - Get Report) . Visa debuted with an Initial Public Offering at $44 per share in 2008, just in time for The Great Recession. The company weathered the downturn, and had a market capitalization at the time of the compilation of this list of $336 billion.

So you see, Blue Chip stocks are less volatile, steady and reasonably safe stocks to invest in, if you intend on holding stocks for a long time. But they also come and go, due to market and even societal forces that change peoples' spending habits.

Introducing TheStreet Courses: Financial titans Jim Cramer and Robert Powell are bringing their market savvy and investing strategies to you. Learn how to create tax-efficient income, avoid mistakes, reduce risk and more. With our courses, you will have the tools and knowledge needed to achieve your financial goals. Learn more about TheStreet Courses on investing and personal finance here.