How to invest in blue chip stocks, exactly? The short answer: carefully, like with any other investment. Investing in blue-chip stocks depends on your preferences, risk tolerance, portfolio objectives and diversification.
When investing in blue chips, making the right choices is essential. We'll help you learn what you need to do to take steps toward buying a blue-chip stock.
What Are Blue-Chip Stocks?
Blue-chip stocks are the very best companies in their respective industries. Their large businesses typically have many years, if not decades, of successful operations to back up the valuation. The phrase "blue chip" comes from poker because blue chips have the highest value. Blue chips may not be the answer if cheap dividend stocks are the goal.
In other words, investors looking for value may not want to invest in blue chips because they tend to come with higher price tags than their competitors. For example, McCormick & Company (NYSE: MKC), which has an unblemished 35-year history of dividend increases, trades at nearly 30x its earnings, while the Kraft Heinz Company (NASDAQ: KHC), which does not have a history of dividend increases, trades for only 15x its earnings.
So, what are blue-chip stocks? They are the leading companies in well-established industries, far from risky penny stocks.
What Makes a Stock a Blue-Chip Stock?
The qualities that make a blue chip are fairly general but come down to its quality as a business. How long has it been operating? How strong is the brand? How good is the revenue and, more importantly, the cash flow? The longer the company has been in operation, the more established its brand, the better the cash flow, and the "bluer" it is. In most cases, blue-chip companies pay dividends as dividend growers because they want investors to buy and hold shares.
Were you wondering about investing in blue-chip marijuana stocks? Think again. Marijuana stocks have not been around long enough to be blue-chip stocks.
Are blue chip stocks a good investment? That depends on the investor. Blue-chip stocks are good stocks to invest in but may only be right for some portfolios.
Why Invest in Blue-Chip Stocks?
Blue-chip stocks offer stability, safety and dividends through companies with well-entrenched businesses that have proven they can stand the test of time (and pay dividends while doing it). Blue-chip stocks also tend to be substantial businesses, large or mega caps, with deep moats related to their brands, product(s) or industries. They offer an element of safety and income for investors in the long haul. Among the many benefits is reduced volatility and, in many cases, market-beating dividend yields. When it comes to the stock market and what risk-averse investors should focus on, there are blue-chip stocks and everything else.
How to Invest in Blue-Chip Stocks
Investing in blue-chip stocks is easy. Here are a few tips on how to buy blue-chip stocks and build a winning portfolio.
Step 1: Build a watchlist of blue-chip stocks.
The first step is to build a watchlist of blue-chip stocks. The list should be diversified and include stocks you might want to buy. You can put together a watchlist of stocks on many stock news sites, including on MarketBeat. The purpose of the watchlist is to develop a list of the stocks you want to build positions in and then keep track of them, waiting for opportune entry points. Entry points are times when the stock's price pulls back from higher levels, offering better value and yield for investors.
Step 2: Pick the right blue-chip stocks.
After building the watchlist, do some more research and decide which blue chip stocks are right for you, such as reviewing the fundamentals of each stock you're considering, such as cash flow and return on assets. The watchlist is something that will evolve. Investors can add new stocks they find or become interested in and also cut out any that don't maximize the portfolios' goals. What makes the right blue chip stocks depends on the investor, the goal of the portfolio and the allocation targets for holdings. A $1,200 stock may be attractive for many reasons, but the price is so high it may be a problematic fit for smaller portfolios. At face value, a single share is worth more than 10% of a $10,000 account and may expose it to undue risk.
Step 3: Wait for the right entry points.
After choosing the target stocks, select your entry points or attractive price points. You can use price points to set limit orders for the blue-chip stocks in a brokerage account. You can base price targets on past price action, technical indications like the 150-day EMA or even the analysts. The analysts' targets, the consensus target, is a closely watched figure for most blue-chip stocks and will often produce strong moves when reached, touched or crossed by the price action.
Step 4: Repeat, choosing the right blue-chip stocks.
After making the first buy, go back to step two and repeat the process. Choose the right stock, pick a target entry and set the order. Do this regularly to take advantage of price swings. Building a portfolio of blue-chip stocks is not a single purchase but repeated buying that creates larger positions over time. In this manner, dividends can be compounded and used to enhance returns.
Pros and Cons of Investing in Blue-Chip Stocks
As with all investments, there are pros and cons to investing in blue chip stocks. Blue-chip stocks have many attractive qualities but are not suitable for all investment accounts, strategies or investors. You also want to consider sectors and industries as well. Blue-chip tech stocks don't perform the same as blue-chip materials stocks or blue-chip consumer staples.
Pros of Blue-Chip Stocks
Let's take a look at the benefits of investing in blue-chip stocks:
- Growing revenue and cash flows: Blue-chip stocks are well-established businesses with stable, if not growing, revenue and cash flows.
- Weathering bad markets: Blue-chip stocks can be counted on to weather ups and downturns in the economy but may perform differently, depending on sector and industry.
- Steady, reliable dividends: Blue-chip stocks tend to pay reliable dividends and many are dividend growers. The distribution can help attract buy-and-hold investors and reduce market volatility in both cases.
- Deep moat: Blue-chip stocks may come with a deep moat based on a product, brand or business.
Cons of Blue-Chip Stocks
What are the downsides?
- No capital gains: The biggest con of a blue-chip stock is that it can be dead money concerning capital gains. In many cases, blue-chip stocks aren't growing anymore. If they are, it could be faster and the growth could be easily priced into the market. These stocks may trade within a trading range or have very slow uptrends to drive their share prices.
- Not the most active stocks: Blue-chip stocks are not the most active ones but are heavily owned and in liquid markets.
Build a Portfolio of Blue-Chip Stocks
Investing in blue-chip stocks is a great way to build a portfolio. However, not all blue-chip stocks are suitable for all investors at all times. Build a watchlist of blue-chip stocks first, then pick the right ones and buy them when they present the best opportunities. Over time, you can build a large portfolio of dividend-paying blue-chip stocks to sustain a comfortable retirement.
Have questions about blue chip stocks? We answer some of the most commonly asked questions here.
How do I invest in blue-chip stocks?
Learn what a blue chip stock is, build a watchlist and then buy the most attractive stocks on a regular or semi-regular basis.
Where does the term "blue-chip" come from?
"Blue chip" is a reference to poker. In poker, blue chips are the highest-valued and most desirable chips. In the stock market, blue-chip companies are the largest, most valuable and most desirable stocks available on the stock market.
Should I buy blue-chip stocks?
Buy blue chip stocks if you are looking for safety and dividends or if you are a buy-and-hold-forever type of investor. They should fit the style and goals of your portfolio.