What are Blue Chip Stocks?

08 Apr 2019

What are Blue Chip Stocks?

The term “blue chips” is often used in reference to stocks – yet many people don’t know what blue chip stocks actually are. In this article we look at the characteristics that make a stock a blue chip, a few examples and all the different ways to trade them.

Definition – What are blue chip stocks?

While there is no precise definition of Blue Chips Stocks, the term refers to the shares of high quality, established and profitable companies. Usually these are companies that have been around for some time, with well known products and brands, and a market leadership position within their sector. In addition, many are multinational corporations with operations around the globe. 

The term “blue chip” actually came from poker because the blue poker chips have the highest value. The term was first used in reference to the stocks of high-quality companies in the 1920s.

Most blue-chip stocks have stable and relatively predictable earnings, and many have attractive dividend yields. These differ from speculative stocks, many of which are not yet profitable or have volatile earnings.

Finally, nearly all blue chip stocks are members of major market indices like the Dow 30, S&P500 and FTSE 100.

Johnson and Johnson 1970 to 2019 – A typical blue-chip stock chart
Johnson and Johnson 1970 to 2019 – A typical blue-chip stock chart

Some Examples of Blue-Chip Stocks

The following are examples of well-known blue chip stocks. This table lists a variety of stocks from different industries that are considered to be blue chips. They are not necessarily the largest or best blue chips, but rather a cross section of examples from different industries.

CompanyShare PriceMarket Capitalization (Bln)
Microsoft$ 117.65$ 892
Apple$ 186.12$ 883
Amazon$ 1,761$ 852
Johnson & Johnson$ 137.60$ 369
JP Morgan$ 106.80$ 345
Exxon Mobile$ 80.87$ 343
Visa$ 154.59$ 336
Walmart$ 99.85$ 289
Bank of America$ 29.65$ 287
Pfizer$ 42.30$ 244
Merck and Co.$ 81.29$ 214
The Boeing Company$ 373.43$ 213
Coca Cola$ 45.46$ 196
Walt Disney$ 110$ 163
McDonald's$ 183$ 140
Starbucks$71.38$ 88

You will probably be familiar with most, if not all ,of these companies. You’ll also notice that they are leaders in their respective industries, and most have been around for 40 years or more.

The Pros and Cons of investing in blue chip stocks

It’s very seldom that blue chip companies go out of business. That means there is less risk of a stock price not recovering after a price decline. 

These are companies that have already proven their business model and have used their retained earnings to grow their businesses each year. Most also have a distinct competitive advantage which makes it very difficult for competitors to take market share from them.

By contrast, stocks that are not considered blue chips are often traded at prices that reflect their future potential, rather than actual profits. If this potential is not realised, the stock price will have to adjust at some point in the future.
Large institutional investors keep most of their funds invested in blue chip stocks and like to buy whenever prices decline. This reduces the volatility of these stocks and increases their liquidity.

The major disadvantage of blue chips is that they don’t grow as fast as smaller, high growth companies. Every year there will be a group of stocks (usually tech stocks) that outperform blue chips – though that outperformance comes with increased volatility and risk.

Some blue-chip companies do eventually go into terminal decline due to changes in technology or consumption trends. Manufacturers of analogue cameras and automakers are examples of companies that are not what they once were. Many traditional high street retail chains are now in terminal decline. For this reason, potential investors should always ask themselves if an industry is likely to exist in the future before investing in a company in that sector.

Most well-known brands belong to blue chip companies
Most well-known brands belong to blue chip companies

How to Invest in blue chip stocks?

There are several ways to invest in blue chips. Besides buying the shares themselves, you can also buy CFDs, futures, options and even binary options on the shares.

Buying And Holding Blue Chip Stocks

The traditional approach to investing in blue chips is to buy them and own them for the long term. This is what Warren Buffett, arguably the world’s most famous investor does. 

There are a few pros and cons to this approach. If you own shares in a company that makes steady profits over time, the company will be reinvesting those profits. That allows the earnings to compound which can really add up over a long enough time period. In addition, if the dividend yield increases over time, you will eventually be earning a very nice income relative to the amount you originally invested.

However, there are some drawbacks to this approach. Firstly, it’s not as easy as it seems to predict the stocks that will continue to generate profits over a very long period. Not all blue chips continue to make money for investors year after year. Polaroid and Kodak were both once considered blue chips, and both ultimately filed for bankruptcy.

Secondly, while blue chip stocks usually generate steady gains over time, their average returns are lower than one can make investing in growth stocks with a shorter time horizon, or by actively trading blue chips.

Trading Blue Chip Shares

Actively trading blue chip stocks can be very rewarding when done right. While blue chip companies don’t have the extremely large price movements of high growth, speculative shares – they don’t carry the same risk. 

Also, their price movements are far more predictable. The shares of these high-quality companies do become overbought and too expensive at times, and this eventually causes their prices to decline. However, large institutional funds are always looking to own blue chips shares when they can get them at good prices. 

As a trader, all you have to do is wait for the price to fall low enough, and then watch for buying volumes to increase and the price to start moving higher. When you see large volumes trading you know the institutions are buyers at that price – and that means there is far less chance of the stock falling significantly further. That gives traders an asymmetric bet, with limited downside, and far greater upside.

Savvy traders can generate large profits by moving from one blue chip to the next - buying cheaper stocks when they see increased buying volume, riding the trend until the price stops rising, and then looking for the next cheap blue-chip stock to buy.

Trading Blue Chip Shares

Futures Contracts

Futures are exchange traded derivative contracts that allow traders to use leverage and to enter both long and short positions. Futures contracts can be traded on equity indexes, commodities, bonds and even on large liquid stocks like blue chips.

They allow active traders to increase their position size without using more capital. Of course, this magnifies both profits and losses, but with disciplined risk management they can be more profitable than trading the stock themselves.

The downside for futures contracts (besides the increased risk), is that the contract size is usually too large for most individual traders. Also, in most cases an account at a dedicated futures broker is required.

Contracts for Difference (CFDs)

CFDs are another type of derivative similar to futures contracts, though they do not trade on exchanges. CFDs can be traded directly with banks and brokers. In most other respects they are exactly the same as futures contracts but have smaller contract sizes – often as small as one share.

CFDs are ideal for retail traders and investors. They allow traders to use leverage by trading on margin and can also be traded on the long and short side. CFDs are therefore ideally suited to anyone wanting to actively trade blue chip stocks.

Exchange Traded Funds (ETFs)

ETFs are baskets of shares that are traded on exchanges just like the shares they hold. In most cases an ETF tracks an index like the Dow Jones Industrial Average, Nasdaq or FTSE 100 index.

Since most major stock market indexes are comprised mostly of blue chips stocks, ETFs offer traders a vehicle to trade a group of blue chips as one security.

ETFs have lower volatility and risk than individual stocks but can also be traded with leverage using CFDs and other derivatives.

Binary Options

Binary options are also a type of derivative but have much higher effective gearing and risk. A binary option is like a bet on whether something will happen or not, and either expires with a large profit or worthless. These instruments can be traded on all sorts of markets over a range of time frames.

For those wanting to bet on blue chip stocks prices reaching specific levels by a specific time or date, binary options are something to consider. However, caution and sensible risk management is advised. 

Conclusion

Blue chips can offer both steady gains over time, and great trading opportunities for active traders. There are also lots of different instruments traders can use to trade blue chips, depending on their personal style of trading.

Libertex is a broker and trading platform which offers CFDs on 50 US and European stocks, most of which are considered blue chips. In addition, clients can trade CFDs on commodities, indices, ETFs and cryptocurrencies with leverage of up to 30 times. To get started learning more about trading blue chips stocks, without risking any capital, you can open a demo account at any time.

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