If the complexity of stock markets sometimes has you baffled, you’re not alone. The world of investing is littered with jargon which can put off newcomers. Keen novices can often be discouraged from investing at all, or become convinced that they have no choice but to trust a high-priced expert to handle their money for them. You could even make the argument that some of the unnecessary jargon in the industry exists for exactly that reason!
But please don’t be one of those people who give up on understanding their own investments. Beyond all the seemingly complicated terminology and processes is a world of opportunity.
Most notably, the chance to take control over your own financial future.
‘Blue chip’ is one of the most widely used terms in the share market. Below we’ll explain what blue chips are, some of the reasons you may want them in your portfolio, and also some of their risks.
Please keep in mind that the information below doesn’t take your personal circumstances into account, and shouldn’t be considered a recommendation. Our editors will regularly recommend shares in our premium publications, sometimes including blue chips, but the information in this article is purely educational.
What is a blue chip company?
Blue chip shares are shares in large corporations which are well-established and financially secure. They’re usually at the top of their sector, and have operated successfully for many years. They’re best identified by a market capitalisation in the billions.
Blue chip classified companies are often household names. Their size and dominant positions give them a reliability that small-cap and mid-cap stocks do not have (small-cap and mid-cap refer to the size of a company’s value on the share market, or capitalisation; large companies like blue chips are often also called ‘large-cap’).
The strengths of blue chip shares
Due to blue chips’ sheer size, they are the most owned shares in the market. They are often considered a safe purchase as their ongoing success is almost guaranteed — note the use of almost, as we’ll return to it later.
Blue chip shares can be tempting to own as they often pay out most of their profits to their shareholders in the form of dividends. Their already large size and strong position in their industry can often mean they don’t need or want to spend those profits on growth. That means you may not be looking at much in the way of capital growth on your investment. But if you’re happy to hold a share long-term for income, blue chips may be your first choice.
And if the company is growing and increasing profits as well, then their potential for investors is even stronger.
Blue chip companies are good to invest in because they have a proven record of ongoing success, with profits and cash available to rescue to them from any possible threat to this success. These shares are the biggest and most dominant companies in the market and often hold up best in any downturn in the economy.
One of the best reasons to invest in blue chip stocks is that they generally are not affected by minor market disruptions or downfalls, or even major shifts in the economy. Consider The Coca-Cola Company for example. They are a multinational blue chip company with a reputation that has jumped every hurdle ever placed in front of them. Despite the many years of revolt against ‘sugary drinks’ in the media, the company has grown exponentially (until recently) since its inception in 1886. Although they reported a slight slip in sales in 2017, Coca-Cola have combated all obstacles by introducing new drink inventions, offering ‘no sugar’ options and different marketing strategies. Ultimately, Coca-Cola is the Kim Kardashian of soft drinks; no matter where you turn your eyes in the dining world, you will find a bottle, can or glass of coke. The reliability is deeply rooted in the flavour of the drink, and in the warm familiarity of the brand name —that’s exactly why people buy them.
Blue chip stocks are the warm safety net investors look to, to pick up easy profits and improve their long-term portfolios.
Blue chip stocks are often considered to be the safest to invest in, as they have billions of dollars to back up their already established business. Not to mention an uninterrupted cash flow. They also pay profits out to shareholders regularly in the form of dividends. For this reason, blue chip shares are some of the most popular to invest in.
However, despite their reliability, they are not the most profitable sector of the market. A massive corporation like Coca-Cola is not going to double in value in a few short months. It’s unlikely to see even a fraction of that increase, in that timeframe.
More often, the biggest gains come from small-cap stocks. These are the smallest companies on the stock market. They tend to be much younger companies, early on in their growth stage. This comes with vastly more risk than in blue chip shares, but also vastly more potential for growth and profits. The dream, of course, is to buy into a speculative small-cap shortly before it launches into its growth journey towards becoming a blue chip stock, and a household name.
Blue chip stocks also come with risks of their own. Just because they’re the biggest companies, with cash in the bank and a dominant position over their competitors, doesn’t mean they can never fail. Major economic crises can smash the value of whole sectors, and even the biggest companies aren’t immune. Nor are they immune from changing times, consumer patterns, technology, or simple mismanagement. Never assume that any investment, no matter how stable, is ‘safe’.
Investing in blue chip stocks can be the safest way to enter the markets. These companies are usually the most insulated from major economic shifts and volatile markets. However, they are not completely immune to the risks that are associated with investing, and should be approached with the same level of research and caution you would apply to any investment.