No doubt you’ve heard the term before: “blue chip stock.” If you’re a newcomer to the area of investing, you might have heard the phrase, but maybe you aren’t 100% sure what it means. If that’s the case, read on to learn a definition, as well as what it might mean to you.
Blue Chip Stocks: A Definition
A blue chip stock is the stock of a large, well-established company that has been operating successfully and profitably for many years. These companies are typically household names, and the leaders in their respective fields. As such, shares of these companies are generally considered to be safe investments, and a wise choice for anyone looking to buy shares.
Because these companies — and their stocks — are so influential and important to the world of investing, their success is measured by blue chip indexes. These indexes track the performance of a few, select companies, and the numbers are often used by analysts to draw conclusions about the market as a whole. The Dow Jones and the Nasdaq are two examples of these blue chip indexes.
What You Need to Know
Even though blue chip stocks are generally considered safe, they’re not without some risks. From time to time, due to bad investments, a changing market, or the inability to adapt to new technology, a company that was once a household name can find itself in danger of failing. In 2008, for example, shareholders of companies such as GM and Washington Mutual learned this the hard way as the global recession brought these once-untouchable companies down low.
Being considered a blue chip stock is not the same as having a wide moat business. Moat, as you recall refers to the competitive advantage a business possesses. For example, as of this writing, I would consider IBM as a blue chip stock but without much of a moat. On the other hand, Amazon seems to possess a nice moat but because they lack consistency in profitability, it is not yet a blue chip stock.
What You Should Do
If you are looking to invest, you should know that blue chip stocks are, typically, a good investment,when bought at a reasonable valuation. Even though there are examples of these large companies failing, their long-established track record means that you are putting your money into an organization that knows how to weather all but the biggest storms. Therefore, putting some of your money in these companies should work in your favor in the long run.
Still, any knowledgeable investor will tell you that blue chips stocks are great, but they should only be a part of your overall portfolio. Diversity is always the key, and the same is true here. Using blue chip stocks to build the core of your portfolio is a good idea, but you should then offset these stocks with other assets, such as mid- and small-cap stocks, as well as bonds and cash.
Finally, always consider valuations. Anything bought at expensive prices will turn out to be bad investment, regardless of its track record and esteem.
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