Blue Chip

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Blue Chip

A "blue chip" is the stock of a well-established, financially sound, and historically secure corporation. According to Ken Kurson, writing in MONEY Magazine, the term itself comes from the early 20th century and was borrowed from the game of poker: blue chips had the highest value. In the investment world, however, blue chip companies are far from being a gamble. They are companies with a history of posting earnings and paying dividends, all while continuing to increase profits. While markets always fluctuate and all companies go though occasional downturns, blue chips are known for strong executive management teams that make intelligent growth decisions and for their high-quality products and services. Blue chip stocks, also known as large cap stocks (because the companies have a high market capitalization of $1 billion or more), tend to rise and fall in conjunction with the stock market in general.

Examples of blue chip stocks include Coca-Cola, Disney, Intel, and IBM. Because the return on blue chip stocks is close to a sure thing, the stocks tend to be expensive and to have a low dividend yield. These drawbacks are offset by the earnings and dividends paid. Most blue chip stocks are offered by companies that have been around for decades, or even longer, but new companies can break into the blue chip ranks if analysts expect the company to last.

Recent example of this phenomenon are Yahoo! and Google, two World Wide Web search engines which may eventually enter the ranks of blue chips. Yahoo! was the highest flyer among Web stocks in the late 1990s. Google is the current sensation (2006). Only time will tell if these companies will eventually take on the permanence and stature of an Intel or an IBM. Meanwhile once unquestionable pillars of the Blue Chip temple, like General Motors and Ford, are fighting battles of survival. Thus even in the world of blue chips, change is the only certainty.

BLUE CHIPS OUTPERFORM OTHER INVESTMENTS

While some people continue to doubt the ultimate financial security of stocks, blue chips are the closest to a sure thing on the stock market—provided that you carefully maintain your list by additions and subtractions. In a 1996 study outlined in his book, Stocks for the Long Run, Jeremy Siegel found that blue chip stocks are quite possibly the best financial investment a consumer can make. Siegel analyzed financial data from 1802 to the present; he found that blue chip stocks were a better investment than gold, bonds, or Treasury bills.

According to a report in Forbes, one dollar invested in stocks in 1802 would have been worth more than $350,000 in 1995. In comparison, a dollar in T-bills grew to only $261, which is only 0.0007 percent of the rate of return on stocks. Treasury bonds did not fare much better, finishing with $752, while gold did even worse, although figures were not available. Inflation and taxes hurt all of the investments, but it hurt bonds worst. Not available until after World War II, bonds would have wiped out many an investor who chose them for his or her only investment. Accounting for inflation and taxes, Siegel found that $1 million invested in bonds immediately after the war would be worth only $218,000 in real purchasing power in 1995. This stretch of history does show that blue chips are a good investment for the long run. But in the financial field, nothing is certain. It should be noted that Siegel's study was completed before the stock market soared to record highs in 1998 and 1999; had such results been included, his case would have been stronger. But a market crash in the intervening time would have changed the conclusions in the other direction.

Financial advisor John Campbell of the firm Goldman Sachs reaffirmed Siegel's buy recommendation in 1998. At that time, Campbell maintained a list of 20 to 25 blue chip stocks that had returned 36.42 percent annually for the three years he managed the list compared with a return of 30.2 percent for the Standard and Poor's 500. Campbell's advice about buying blue chips, which he discussed in Fortune, was to "invest in the best businesses and the best managements, pay a fair price, and over the course of your life your stocks will do better than the market."

POSITIVE AND NEGATIVE ASPECTS OF BLUE CHIPS

As with any stock, there are positives and negatives with blue chips. Because blue chips are the oldest and best-known companies, they are easy to follow, often ending up on the front page instead of just in the financial section of the local newspaper. Investors can thus track these companies and evaluate their advertising and marketing strategies. Finally, they are a great tool for teaching kids about the stock market by using brand names they recognize, like McDonald's or Walt Disney.

The negatives associated with blue chips are basically the same as for other stocks. Even blue chips can take a nosedive. And as the old saying goes, "the bigger they are, the harder they fall." The more you have invested in a company, the worse its mistakes can be for your portfolio. In addition, blue chip stocks often pay smaller dividends than even the 4 percent yield associated with income stocks. This puts off some investors.

Most blue chip stocks are traded on the New York Stock Exchange and make up a significant portion of the Dow Jones Industrial Average and the S & P 500 Index. They can be purchased through brokers or online. The best time to buy blue chip stocks is after a disappointing earnings report or after a particularly bad public relations blunder: the stock is sure to dip then, making it more likely that you will buy low and be able to sell high later. If you divide the company's net assets by the number of shares it has outstanding, and the stock is selling for less than that number, consider buying because it is a very good value at that point. Also, try to avoid companies that have accrued a large amount of long-term debt.

see also Fortune 500