You must have heard or read about “blue chip stocks” in business news channel or newspaper.
These stocks are often considered safe bets which can provide you with a much better return in future.
The domain of equity trading, bonds, and mutual funds have opted for blue color since traditionally it has been used to denote wagering chip that has the highest intrinsic value, while other colored chips like red or white represent lesser value.
In this article, we will learn that why blue-chip stocks are worth more than others and the benefits associated with holding blue-chip stocks in the portfolio.
What are Blue Chip Stocks?
A blue chip stock is a stock of financially sound and well-established company, which have a large market capitalization and are leaders in their respective sector or industry.
They deliver strong financial results and rewards shareholders with regular dividends.
Though dividend payment is not the main characteristics of these companies, rather they have a long track record of rising dividend payment and increasing shareholder value.
Moreover, these companies are part of the reputed market indices like Nifty 50 and Sensex.
In order to qualify as a blue-chip stock, the stock should have a stable and well-established track record over a longer time frame.
This shows that the company is sound and capable enough to withstand the roller coaster cycle prevalent in the stock market.
Some of the parameters to qualify a stock as a blue chip includes consistent annual growth in both top line and bottom-line over a bigger time horizon, stable debt-equity ratio, average interest coverage ratio and ROE, growth in dividend payout etc.
People believe that holding a portfolio of blue-chip stocks is enough to provide a superior return. However, in the practical world, the key to any investment portfolio is through diversification.
Blue-chip stocks are present in most industries so the better alternative is to construct a well-diversified portfolio of such stocks of diverse sector or industries so as to enjoy a stable growth and sound peace of mind. Though there is no definite list, few examples of blue chip stocks are stated below-
1. Asian Paints
3. Sun Pharma
4. Coal India
8. Reliance Industries
10. ICICI bank
History of Blue Chip Stocks
The term “blue chip” was coined by Oliver Gingold (who worked at Dow Jones) in the year 1923.
The term came into existence when Gingold who was standing beside the stock ticker at a brokerage firm discovered that few stocks are trading at $200 or more per share.
He named those stocks as blue chips and even wrote an article on them.
This is how the term came into existence.
Soon after the blue-chip have been extensively used to refer high priced quality stocks which are expected to deliver a superior return in the long run.
Some people also believe that the term blue chip stock is named after the high valued chips in the game of poker where the blue chips have the highest value while the one in white has the lowest value.
Hence, the term blue chip as these companies gives a reputation of giving excellent results even in the turbulent times, enjoys strong brand name and have a long history of strong earnings growth.
Blue Chip as a percentage of the overall portfolio
Though blue-chip stocks are suitable for building a portfolio, however, they shouldn’t be your entire portfolio.
A well-diversified portfolio should have a proper mix of equity, bonds, and cash.
So if we narrow down our view on equity, there should be good diversification in terms of blue-chip stocks, small caps, and mid-caps.
Read here: Portfolio Diversification Simplified
Safety of blue-chip stocks
Though a blue chip company has passed through several market cycles and survived a number of challenges in the past so it shouldn’t be perceived as a safe investment forever as it may not always be the case.
Some of the good companies globally like Lehman Brothers and General Motors have even struggled hard during the time of extreme stress in the economy in 2008.
Blue chip stocks may not provide superior short-term profit but have a track record of creating highest long-term value since they pay a regular dividend, grow steadily and recovers fast from a fall in the bearish market.
A person with a basic level of intelligence can make a good profit in the long run by simply diversifying the portfolio in blue-chip companies. For any doubts, please post it in the comment section below.
Take care and keep learning!