The Benefits of Owning Blue Chip Stocks

what is blue chip shares

By Joshua Kennon. Investing for Beginners Expert

Thanks to his straight-forward approach and ability to simplify complex topics, Joshua Kennon's series of lessons on financial statement analysis have been used by managers, investors, colleges and universities throughout the world. "If an investment idea takes more than a few sentences, or cannot be explained to a reasonably intelligent fourth grader, you've moved into speculation," Joshua insists. "Whether you're dealing with a public company such as McDonald's, or a private company such as Chanel, these are the types of firms that are easy to understand. You know where the sales originate, what the costs are, and how profits are generated. These are the types of enterprises that aren't going to cause you to wake up in the middle of the night, breaking into a cold sweat because of the sub-prime crisis or esoteric securities trading in illiquid markets. That's a huge advantage to growing your wealth. Focus on what you know, pay a fair price, and invest for the long-term.

Continue Reading Below

Yet, the prosaic nature attributed to them is certainly not deserved as there is nothing more exciting than making a profit.  Profit is certainly what blue chips are all about.  If you choose them wisely, and hold them for decades, they can shower your family in ever-increasing streams of dividends .

The Definition of a Blue Chip Stock

The exact criteria used to classify a company's stock as a blue chip is relatively subjective. The title rests upon numerous ambiguities (perhaps Supreme Court Justice Potter Stewart's famous definition applies to blue chip stocks as well as obscenity, "I can't explain it but I know it when I see it").

Most professional investors agree that blue chips share several important characteristics including:

  • An established record of stable earning power over several decades
  • An equally long record of uninterrupted dividend payments to common stock holders
  • A history of regular increases in the dividends payable to each share
  • Strong balance sheets with a moderate debt burden
  • High credit ratings in the bond and commercial paper markets
  • Large size relative to American businesses as a whole in terms of revenue and market capitalization

Continue Reading Below

  • Diversified product lines (e.g. General Electric) and / or geographic location (e.g. Coca-Cola).
  • A competitive advantage in the market place due to cost efficiency, franchise value or distribution control

The Dow Jones Industrial Average

These characteristics usually help blue chip companies maintain their leading industry positions. The moderate debt levels and excellent credit ratings allow them to borrow money at a lower cost than their competitors. Excellent market place reputation also results in higher sales; a consumer is more likely to purchase a brand with which he is familiar despite a slightly higher price tag.

Perhaps the most famous list of blue chip companies in the world is the Dow Jones Industrial Average. This collection of thirty stocks is selected by the editors of The Wall Street Journal. The only requirement for inclusion in the index is industrial leadership. Despite this seemingly low-hurdle, each potential Dow component undergoes incredible scrutiny, resulting in a list that stands as the most prestigious roster of blue chips in the world. The individual companies that make up the index rarely change, which shouldn't come as a surprise given the inherent stability of blue chip stocks.

Investing In Blue Chip Stocks

There are several ways to invest in blue chip stocks. An investor can acquire shares directly through a broker. a direct stock purchase plan or a dividend reinvestment plan. He can also purchase a mutual fund that specializes in blue chip stocks.  Another option is exchange traded funds, or ETFs, such as the SPDR Dow Jones Industrial Average (ticker symbol DIA), which holds a portfolio replicating the index for which it is named.  Buying it, the owner gets a basket of shares in companies such as Exxon Mobil, McDonald's, Coca-Cola, Microsoft, Nike, Procter & Gamble, Wal-Mart, AT&T, Disney, Merck, and Visa, to name a few, all for a single brokerage commission and a low expense ratio .

There are times you might consider selling a blue chip stock. but the list of such situations is fairly short.  Parting with a good holding should be like selling the family farm - you don't do it lightly, you think about it a long time before you make the decision, and you are absolutely certain you no longer want it in your life.

More Information About Investing in Shares of Stock

If you want to learn how to invest in stock, read our guide to investing in stock.

Source: beginnersinvest.about.com

Category: Forex

Similar articles: