Investing in Blue-Chip Companies

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by Adedamola Bada · 6 min read
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Investing in Blue-Chip Companies

IBM, Alibaba, Berkshire Hathaway, Facebook and Coca-Cola. They all come from different industries, but they all have something in common – they all known as “blue-chip” companies.

A blue-chip company is a financially sound, well-grounded and globally-known institution. These companies are known for their consistency in delivering high-quality products and services for a very long period. Blue-chip companies are famous for remaining in profit despite unstable economic conditions.

The name ‘blue-chip’ comes from the famous game of poker in which the highest value that can be staked is assigned to the blue chips. This term was initially used in 1923 by Oliver Gingold to describe stocks with high prices – trading at about $200 per share. Over time, the use of this term changed from description of high priced stocks to a description of companies that have stood the test of time with amazing records.

What Companies Are Blue-Chip?

Blue-chip companies are mature companies that have proven to be trustworthy in the delivery of their products and services over a long period. Blue-chip companies are powerhouses in whatever industry that are known to be safe investments because of their financial stability and consistency in generating profits regardless of the situation of the economic markets.

Generally, these companies are known to have a very consistent growth rate as they post steady profits year after year. Unlike older times when companies needed a long history of excellent financial performance to be regarded as blue-chip, that is not the case anymore – relatively young companies such as Amazon and Facebook are less than 30 years old. The term ‘blue-chip’ applies to not only the company but also its stocks.

Understanding Blue-chip Stocks

Just like regular stocks, blue-chip stocks describe stocks but only those of high valued assets (indexes and averages) such as Nasdaq-100, TSX-60, Dow Jones, FTSE, etc. The requirements regulating which institution can be referred to as a blue-chip company aren’t exactly set. However, a market capitalization of $5 billion is generally accepted as a benchmark for attaining the revered title.

While dividend sharing is an important part of every business, it is not a pre-requisite for referring to business as a blue-chip. A consistent rise in dividends or income plays a vital role in giving a company the right to be referred to as a blue-chip company.

Talking about blue-chip companies, the likes of Google, Coca-Cola, Facebook, etc. come to mind since they are forces to be reckoned within their respective industries. These companies have built a reputation and survived several economic downturns over the years which has earned them the deserving respect.

Stocks from blue-chip companies are usually preferred by conservative investors over all other stocks because of the low risk associated with them. They are best for conserving capital because of the consistent return on investment provided.

However, even though blue-chip companies have been praised to be financially stable and investing in them would likely lead to a positive result, this is not always the case. The worldwide recession of 2008 led to the winding up of blue-chip companies such as Lehman Brothers and General Motors.

Are Blue Chip Stocks Worth Investing?

Many investors consider the purchase of blue-chip stocks uninteresting and old-fashioned. However, if you go through the portfolios of super-rich individuals, you’ll notice they invest a good part of their money in blue-chip stocks. Essentially, this signifies that financially sound people see something most don’t in blue-chips.

While blue-chip stocks do not grossly increase in price like firms with smaller market capitalizations, they consistently pay out dividends to shareholders over decades. They may actually generate an impressive return on investment over the years which compound at 8-12%. Once these profits are made, they then become reinvested into the stocks to steadily enlarge a portfolio.

High net-worth individuals even purchase blue-chip stocks as a way of avoiding taxes and giving them out as an inheritance to their kids. For instance, if your kids inherit your estate after it has grown in value, the capital gains tax that should have been paid on the price increase would be overwritten. This allows your children to enjoy your profits in peace. This is considered a tax loophole.

Blue-chip stocks are also viewed as safe havens during busts in the economic cycle. Several investors with portfolios not larger a few thousand or tens of thousands hardly ever consider this fact because they’re more focused on insane returns on investment. For most, it never goes the positive way as no one can accurately predict what product or service would be highly utilized in the future.

Hence, the moment there is a drop in market capitalization in the stock market, they lose money. Companies with a smaller market cap get hit very badly in a bear market. Blue-chip companies also experience a reduction in share prices during an economic downturn. However, the price drop would be relatively small when compared to that of other companies.

Top 5 Blue-Chip Stocks to Buy in 2020

1. Berkshire Hathaway

Berkshire Hathaway stands out as a ‘unicorn among unicorns’, owing to its steadfastness in securing profits. Warren Buffett, the man heading the business conglomerate frequently churned out profits for the company by purchasing a large number of assets below their market prices.

Berkshire Hathaway buys varying types of assets from companies that always need immediate cash at lowered prices. The ‘unicorn’ has a lot of cash, running into about $130 billion to spare and basically uses its enviable liquidity to get what it wants.

2. Alibaba

While a few investors may have objections about Alibaba being the typical blue-chip company, it certainly qualifies as one. The total stock of the tech giant is at $500 million and is still grossly increasing in value. In fact, Alibaba has been viewed as a better investment than its major competitor, Amazon.

The division of the company that branched into the cloud business grew by 1.64 times last quarter. Despite Chinese businesses suffering from the US-China trade war, Alibaba seems to be growing at a steady rate. The end of the trade war would signify a massive increase in share prices of Alibaba.

3. Johnson & Johnson

This is a blue-chip stock that has been around since 1887. The reason investors are attracted to JNJ is its stability and seeming protection from downward economic movement. JNJ majorly offers health products and consumer staples. It provides 2.7% dividends for investors and is positively viewed because of stock ability to rise against the US dollar over the years.

4. McDonald’s Corp.

McDonald‘s stock was one of the very few that stood strong during the global financial crisis. At the start of the GFC, McDonald’s multiplied its dividend payments, a trend it has maintained for the past 4 decades. It provides 2.6% dividends for investors and is considered a giant in two sectors namely real estate and food.

5. Duke Energy

Duke Energy is an energy providing company that supplies electricity for as much as 7.7 million clients and gas for 1.6 million. The company provides a dividend of 4.2%. it is certainly a safe investment to make as electricity is a commodity that will always be demanded. The company reinvests 77% of its profits to fund it. Its stock is also well-insulated against economic downturns.

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