The Benefits of Blue Chip Stocks
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Investing in Sound, Predictable and Established Companies
Despite their reputation as boring, sluggish and perhaps even a little outdated, Blue Chip stocks have long reigned supreme in the portfolio of retirees, non-profit foundations and conservative individuals. These companies often reside at the core of a countries business. Yet the prosaicness attributed to them is certainly not deserved because there is nothing more exciting than making a profit and that is certainly what blue chips are all about.
The term Blue Chip actually comes from gambling where the highest and most valuable playing chip is blue.
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 factors. Most professional investors agree that blue chips share several important characteristics including:
- An established record of stable earnings 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.
- Large in size relative to a countries businesses as a whole in terms of revenue and market capitalization.
- 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 efficiencies and/or distribution control.
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 incredibly 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 are rarely changed; considering the inherent stability of blue chip stocks, this should come as little surprise.
Investing In Blue Chip Stocks
There are several ways to invest in blue chip stocks. An investor can acquire shares directly through a broker, purchasing stocks directly or a dividend reinvestment plan. He can also purchase a mutual fund that specializes in blue chip stocks. Another effective way for the average investor is to invest in the Diamonds Trust (DIA).
The DIA is an investment instrument traded on the American Stock Exchange (AMEX). By purchasing one share of the DIA, an investor is purchasing a fraction of each of the thirty components in the Dow Jones Industrial Average meaning, you are investing in the entire index.
The DIA is preferable over blue chip mutual funds because of their low expense ratio as well as tax efficiency; because they are traded on an exchange, the underlying shares are only sold to reflect a change in the companies making up the Dow, resulting in lower capital gains taxes.
Ricky Schmidt
October 1, 2004
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