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What are Blue Chip Stocks?

To see some of the best examples of blue chip stocks, look no further than the companies in the Dow Jones Industrial Average. You’ll find Microsoft, Apple, Walmart, Disney, McDonald’s and Coca-Cola.

Why blue chip stocks are different

Generally, blue chips are regarded as the best of the best. That doesn’t always mean the best one-year performance. That honor often belongs to smaller companies, equities that might continue rising or that might flame out just as spectacularly.

Blue chips are sturdy and dependable. They’re big companies as opposed to startups or middle market companies that haven’t yet found their stride. Blue chips also have a reputation for maintaining profits and stock performance regardless of what the rest of the market or economy is doing.

That’s not to say that large market movements won’t move blue chips as well, but you can think of a blue chip stock as an ocean liner while many other stocks are much tinier.

During the market crash of 2008 and 2009, the S&P 500 lost nearly half its value, while some key names in the Dow held their own. Walmart, a blue chip, was up.

They define an industry

Imagine any large industry and one or two blue chip stocks are likely to come to mind. When we think of the computer industry, we think of Microsoft, Apple and Intel, all blue chip stocks, and all companies that help to define the industry as a whole.

Because blue chip stocks are often the defining brands in large industries, you’ll find that they have a market capitalization measured in billions, often hundreds of billions, or even approaching a trillion dollars, like Apple.

Higher dividend payouts

Just as there’s no official definition for blue chip stocks, there’s no requirement that a blue chip stock pays a dividend, but it’s a common trait. Companies like Cisco pay a dividend of nearly 4%, General Electric pays its shareholders nearly 3.5% and Coca-Cola investors enjoy a brisk and refreshing dividend of over 3%.

The current dividend yield for Verizon is a whopping 5%. Some blue chip companies, however, aren’t as attractive for investors seeking growth through dividends, like VISA, which currently pays less than seven-tenths of a percent as a dividend yield.

The effect of reinvested dividends on a portfolio over the long term can create stratospheric gains. Reinvested dividends purchase more shares which then pay more dividends, and this process repeated over decades has helped build the treasure chests of some of the world’s wealthiest people. Dividends aren’t everything.

Many of the equities with the highest dividend yields in the years leading up to the 2008/2009 crash were real estate investment trusts (REITs), which sometimes paid double-digit dividend yields.

Many of those same names are trading for pennies on the dollar now — or have disappeared into obscurity — illustrating the importance of being able to grow revenue and profit consistently with a sustainable business model. Blue chips can have down or flat years in regard to profit performance but don’t usually miss the mark by much, making recovery nearly a certainty because of their brand awareness and entrenched market share.

Blue chips origins in American poker

The term “blue chip” has its origins in the game of poker. In American style, a basic poker set has red, white, and blue chips, which have the highest value. Most investors know that there’s no such thing as a safe bet but blue chip stocks are often regarded as safer than other investments.

In many cases, that’s true. However, many big names in the blue chip stock world have fallen over the years, including Washington Mutual, Bear Stearns, Lehman Brothers and General Motors. Branding has value and it’s possible some of these companies can return to their once lofty positions within their respective industries.

Most blue chips keep on chugging, increasing sales and profit consistently.

Blue chip ETFs

Investing in blue chip companies is easier than ever, with a number of blue-chip focused ETFs available, index ETFs that track the Dow, or even ETFs that track dividend-focused strategies for blue chip companies, such as the Dogs of the Dow strategy, which specifically targets the 10 companies in the Dow Jones Industrial Average with the highest dividend yield.

Of course, a number of blue-chip focused mutual funds are available as well, with mutual fund leaders like Vanguard offering options for automatic investing, making investment allocations effortless and painless.

Final thoughts

In a way, we’ve been fortunate to see the level of stock market volatility that we’ve witnessed in our lifetimes because it’s a reminder that that which goes up can also come down — but also that companies with consistently proven earnings and that provide the products or services that are part of our everyday lives are the most likely to survive stormy seas.

Blue chip stocks often represent who we are as a society, defining not only their industry but, when viewed as a group, broadly defining the American consumer by extension.

What’s even better is that blue chip stocks often pay us dividends for investing in the companies that make the products or provide services we purchase every day.

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