Investing in the stock markets carries risks: stocks don’t always go up. Stocks are also an asset class that has generated massive wealth for long-term investors.
There are several ways investors can gain exposure to the equity market while limiting risk. For example, individuals can invest passively in stocks via exchange-traded funds or ETFs, providing more diversification than any portfolio of individual stocks.
Alternately, they can also identify individual stocks with the potential to deliver respectable gains with limited downside. A popular investment strategy is to invest in blue chip stocks, which will help market participants derive consistent returns without the volatility associated with more speculative growth-oriented stocks.
What are Blue Chip Stocks?
Blue chip stocks are stocks of well-established industry-leading companies. These companies are typically household names, with a global market presence, a wide economic moat, and substantial market share.
With decades of experience and a portfolio of well-established products, these companies have robust cash flows, solid profit margins, and stable revenue growth.
Due to their colossal size, blue chip companies tend to be major constituents of benchmark stock indices, such as the Dow Jones Industrial Average (DJIA) or the S&P 500. This attracts stable ownership from index funds that automatically buy stocks that belong to those categories.
While there are no established classification criteria that define such companies, a going concern with a market cap greater than $10 billion with strong fundamentals, and a dominant competitive position may generally be regarded as a blue chip stock.
Why Invest in the Best Blue Chip Stocks?
Most equity portfolios of retail and institutional investors tend to contain some blue chip stocks. Many risk-averse investors hold a substantial amount of their total portfolio value in blue chip stocks, thanks to their relatively stable nature.
Long-term investors may look to purchase blue chip stocks and hold them for years on end, generating solid returns through share price appreciation and dividends.
Investing in blue chip stocks has the following advantages:
Ride Out Market Volatility
Stock markets can be volatile, and we’ve seen several market crashes in the last two decades. In mid-2022 stock markets have been correcting since the beginning of the year due to surging inflation rates, hawkish monetary policies, decelerating economic growth, and extended geopolitical tensions. As a result, U.S. indices such as the S&P 500 have slumped nearly 20% in 2022, while the tech-heavy Nasdaq Composite Index is down 28% year-to-date, wiping almost all of its post-pandemic gains.
Blue chip stocks will fall during a general correction, but they generally fall much less than shares in less established companies. They can shield you from such market fluctuations and are ideal investments during a bear market. You can compare blue chip stocks to safe-haven assets such as gold.
These companies typically have strong financials and can withstand market downturns or even an economic recession. In addition, given their decades of experience in their respective industries, blue chip companies tend to have a diversified revenue base, allowing them to hedge their operations from fluctuations in one particular sector.
Blue Chip Dividend Stocks can Help You Generate Passive Income
Unlike small and mid-cap companies, most blue chip companies pay substantial dividends to their shareholders. Blue chip companies don’t offer the kind of exponential growth potential that new companies advertise, so they use dividends to attract investors.
Fundamentally strong stocks often expand revenue and profit margins over the long term, allowing them to increase dividend payouts without compromising operational efficiency.
On the other hand, small and mid-cap companies generally reinvest a majority of their profits back into the business to expand their operations.
As blue chip companies enjoy a broad multi-national customer base, their revenues tend to be relatively stable. Moreover, with sizable cash flows and retained earnings, most blue chip companies maintain their dividend payments despite market downturns. Income-seeking investors can easily create a passive income stream by investing in dividend-paying blue chip stocks.
Dividend income can also act as a hedge against inflation, as blue chip companies typically raise dividends periodically. With global inflation rates hovering around record highs, investing in the best blue chip stocks with dividends can help investors generate considerable real returns.
Dividends are also a reason why blue-chip stocks decline less during market downturns. As stock prices fall dividend yields rise, drawing in buying from income-focused investors.
Robust Total Shareholder Returns
Besides dividend income, blue chip stockholders stand to gain from the share price appreciation. Historically, the shares of blue chip companies have risen consistently. These companies typically show slow but consistent growth over time.
While several stocks are trading at depressed valuations in 2022, investors can view the pullback as a buying opportunity and purchase quality stocks at a steep discount. Yes, bear markets are extremely scary, but generational wealth is created in periods of economic volatility.
As the equity markets rebound from the bear territory, undervalued blue-chip stocks are bound to gain momentum, thereby generating substantial capital gains for stockholders.
Some Sample Blue Chip Companies
Below is a list of blue chip stocks you can add to your watchlist right now.
There are blue chip stocks in every economic sector, and tech is no exception. One of the largest companies in the world, Apple is valued at a market cap of $2.35 trillion. While the tech giant generates most of its sales from its iPhone business, it is a market leader in categories including wearables and music streaming.
Apple’s Services business is its second-largest segment and a key revenue driver for the firm. It now has various subscription offerings, including Apple Music, Apple Care, Apple Arcade, and Apple TV+, allowing the company to generate recurring sales across business cycles.
Apple pays investors annual dividends of $0.92 per share, translating to a forward yield of 0.63%. AAPL stock has entered the bear market territory and is down 20% from all-time highs. However, it has returned 685% in dividend-adjusted gains to investors in the last ten years. Comparatively, the S&P 500 index has gained 250% since July 2012.
With a $28.48 billion market cap, Fortis is one of Canada’s largest electric and gas utility distributors. Founded in 1885, it is among the oldest electric utility companies operating across Canada, the United States, and other Caribbean countries.
Fortis is a Dividend Aristocrat stock, as it has increased its dividend payouts every year for the past 48 years. It currently offers a juicy forward yield of 3.5%. Moreover, the stock is currently trading at only 2.78 times its forward sales and 8.72 times its forward cash flows, which is reasonable.
Fortis is one of the best blue chip stocks with an impressive dividend payout history and is poised to weather the current market downturn as well as a potential recession.
One of the most prominent players in the insurance industry, Berkshire Hathaway commands a market cap of $615 billion. It offers multiple lines of personal and commercial insurance via subsidiaries such as GEICO.
Berkshire also owns a utility business, a restaurant chain, and a railroad company making Berkshire Hathaway among the most diversified businesses globally.
While Berkshire Hathaway does not pay investors dividends, its stock has returned 235% in the last ten years.
Coca-Cola is a Dividend King and has increased dividends for 60 consecutive years. One of the most recognizable brands in the world, Coca-Cola has managed to increase its revenue at an annual rate of 5% in the last 30 years. In Q1, its revenue surged by 16% year over year to $10.5 billion, while earnings soared by 16% to $0.64 per share.
Its stellar top-line growth allowed the consumer products heavyweight to improve operating margins from 32.5% in Q1, compared to 30% in the year-ago period. It’s also a top stock to hold amid rising inflation rates, given Coca-Cola enjoys significant pricing power.
In 2022, Coca-Cola forecasts sales growth between 7% and 8%, while adjusted earnings are estimated to rise by 6% this year. It’s on track to report a free cash flow of $10.5 billion in 2022, which indicates further dividend increases are on the cards.
While banking companies are cyclical in nature, J.P. Morgan is well poised to benefit from rising interest rates. In fact, J.P. Morgan expects net interest income to touch $56 billion in 2022, up from $44.5 billion in 2021, due to higher interest rates.
However, these gains will be offset by falling home loan originations which were already down 37% year over year in Q1.
J.P. Morgan has a solid balance sheet and ended Q1 with a cash balance of $625 billion, an increase of 24% year over year.
J.P. Morgan offers investors a dividend yield of over 3% above its 10-year average yield of 2.6%. The stock is also trading at nine times forward earnings which is quite reasonable. J.P. Morgan is a cheap blue-chip stock with significant upside potential.
Limitations of Investing In Blue Chip Stocks
Investing in blue chip stocks is ideal for those looking to generate consistent returns. They are less likely to generate the kind of exponential gains sought by more aggressive investors. Blue-chip companies tend to be mature businesses that already dominate their industries, so they do not have the potential for explosive growth.
While these companies showcase their durability in bear markets, they may significantly trail growth stocks in a bull market.
The Dow Jones Industrial Average Index can be considered a proxy for investors to gain exposure to blue chip stocks. Between January 2012 and January 2022, the Dow Jones Index returned 241% to investors. Comparatively, the tech-heavy Nasdaq Composite index, which comprises some of the fastest-growing tech stocks, rose close to 476% in the 10-year period.
Alternatively, while the Nasdaq Composite index is down 29% from all-time highs, the Dow Jones index is trading 14.5% below record levels.
In a nutshell, blue chip stocks are a top bet for investors with a low-risk appetite looking to gain exposure to the equity market. Some investors see blue chips as boring stocks, but for others, boring might be exactly what they’re looking for.
The Final Takeaway
Blue chip stocks are considered the crown jewel of investing and are the all-time favorites of value investors, including the legendary Warren Buffet. As seen above, these stocks typically have minimal risks associated but can generate generous returns over time.
The ongoing market crash has also increased the dividend yields of several companies higher. Dividend yields and stock prices have an inverse relationship, so the stock market sell-off allows investors to lock in high dividend yields at a cyclical low, given the prospects of a market recovery are uncertain.
Blue chip stocks can be a buffer during periods of heightened market sluggishness, thanks to their strong cash flows and solid financials. Investors are currently deterred by the increasing market risks and bearish sentiment, so investing in the best blue chip stocks can substantially hedge their portfolios.
Moreover, given the sky-high inflation rates, blue chip dividend stocks can be used to mitigate inflation risks as well.