Blue-chip stocks are shares of large, established, and financially stable companies that have been around for a long time. The term "blue chip" comes from the game of poker, where a blue chip holds the highest value. On Wall Street, a blue-chip stock is usually a highly valued and well-known company with characteristics that benefit investors over the long run, such as stable cash flows and consistent dividends.
Blue-Chip Stock Stability
Most investors understand that blue-chip stocks have stable earnings. During an economic downturn, investors may turn to these perceived "safe havens" because of their steady nature. Some people believe that blue-chip companies can offer security during periods of slower growth due to their experienced executive teams combined with their ability to generate stable profits.
Key Takeaways
- The term "blue chip" comes from poker, where the blue chips hold the highest value.
- On Wall Street, blue-chip stocks are shares of large established companies with steady financials and consistent dividends.
- Since many blue chips are large familiar names, investors typically invest with confidence, believing that these stocks will be the first to rebound after a bear market.
- Consistent dividend payouts over the years can help add an element of stability to share prices as well.
A blue-chip stock is typically large in size (with a market capitalization in the billions) and a leader in its sector or industry. The company is usually a familiar and easily recognizable name, which gives investors a sense of added confidence when adding the stock to their portfolios. That's because, if stocks fall into a bear market, these well-established popular names will likely be among the first to recover. There is little risk that they will go out of business during an economic downturn.
Blue-Chips and Dividends
Since blue-chip shares are typically mature companies that have achieved large market caps, most pay dividends. Dividends represent a portion of the company's profits that are distributed to shareholders in the form of quarterly payments. Smaller companies that are growing fast typically retain all of their earnings in order to invest in future growth. These growth stocks may eventually pay dividends once they are of sufficient size and begin to see fewer opportunities to invest in themselves. At that point, they begin distributing excess earnings to their shareholders. Until then, a fast-growing or young company is not likely to pay any dividends.
A blue-chip stock, on the other hand, has seen increased and uninterrupted dividends over time. In the long run, the benefit to the shareholder from the dividend payments is portfolio income, regardless of the daily swings in the share price. Dividend payments can also help to protect against the adverse effects of inflation because dividends represent earnings, which can increase along with the general cost of living.
The Bottom Line
Blue-chip stocks typically have solid balance sheets, steady cash flows, proven business models, and a history of increasing dividends. For that reason, investors generally consider blue-chip stocks to be among the most secure stock investments because of their track records and performance history. So, while blue-chips are not immune from losses if the broader stock market enters a bearish phase, the idea is that these names will be less volatile than smaller growth companies and will also be the first to rebound when the market eventually recovers.
