Blue chip stocks are large companies that dominate the industry they are in. These are household names that are in virtually every mutual fund and portfolio. International Business Machines (IBM) has the nickname “Big Blue” since it used to be one of the biggest and most owned company in the world.
Most blue chip stocks have been around for many, many years. These are companies like Coca-Cola, Home Depot, General Electric, Exxon, and Microsoft that have been through many business cycles and used each downturn to take business away from rivals and come out a stronger, larger company. They tend to have thousands of employees and be in several different markets.
Probably the most famous list of blue chip companies is the Dow Jones Industrial Average, or DJIA, which contains the largest and most influential industrial companies. The idea behind the DJIA is that where the DJIA goes, so goes the economy since the most important companies in the economy are in the DJIA. There are also blue chip companies in the Dow Jones Transportation Index and the Dow Jones Utilities Index. Dow theory says that if the Transports and the Industrials are either rising (in an uptrend) or falling (in a downtrend), then it is a true trend. If they are mixed – one going up while the other goes down – then it is not a true trend.
The easiest way to spot a blue chip is just to look for the dominant companies that you know. Blue chip stocks are the companies like McDonald’s that a school child would choose in a stock picking game because they have been heavily advertised to by them and they know their products well. Most blue chip companies are also probably companies you’ve grown up with, although the internet has caused some blue chips to be developed very rapidly. For example, Amazon did not exist before 1994, yet by 2000 it was a household name and was dominating the selling of virtually everything. Google is another example that grew very big very fast.
Blue chip companies are sometimes good choices for growth – some large companies do very well over certain periods of time, but generally they are purchased more for stability than for growth. Many also pay good dividends, and grow their dividends regularly, so they are a good way to generate the income needed once you begin using your portfolio to pay for current expenses. The reason they are not as good for growth as small companies is that they are already so large that it is difficult for them to do things like double profits, which is what is needed to double their share price.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.