Many investors and non-investors alike have heard the term “blue chip stock,” but what does the term really mean? Where does it come from? Why blue, and not purple, green, lavender, or lilac-beige?
Well, the term blue chip stock is taken from common poker betting systems. Chip sets frequently valued blue chips higher than white and red ones. Common systems valued white, red, and blue chips at $1, $5, and $10, respectively.
No one is entirely sure why blue has traditionally been the highest valued color among chips, but chances are that it has to do with the color’s association with royalty and wealth. Blue-dyed cloth was once a privilege of kings. Aristocrats and people from wealthy families are often referred to as “blue-bloods.”
According to a Dow Jones internal news item, the term was first used in relation to stocks somewhere around 1923 or 1924. An employee of Dow Jones noticed many high price stock trades and remarked that he would return to his office to “write about these blue-chip stocks.”
The contemporary meaning of blue chip is much more easily explained. Blue chip stocks are those with a reputation for reliability and sound management, and a history of growth. Blue chips are valued for their ability to operate profitably during any economic times both good and bad. The Dow Jones Industrial Average reports the weighted average of 30 US blue chip stocks considered leaders within their industries.
Typically, blue chips are very large companies. In fact, many investment research firms set a minimum market capitalization – the number of outstanding shares multiplied by the per share price – as one criteria for naming a stock a blue chip. This minimum is often in the billions of dollars.
Blue chip companies tend to be large because they’ve been in business, and growing, for a long time. Having a proven track record of growth naturally requires growth over a long period, making the company quite large.
Blue chips can share a number of other characteristics. Many blue chip stocks pay dividends. Frequently, blue chip companies have grown so large that there is little reason to set much money aside for growth.
Many blue chip stocks are so well known that it would be hard to imagine an economy without them. A look at the companies in the Dow Jones Industrial Average makes this clear. All of the companies listed there are economic stalwarts. Although anything can happen, companies like Coca-Cola, McDonald’s, and Microsoft are so infused into the stock market that it’s difficult to imagine circumstances in which they lose unsustainably large amounts of money.
The trade-off for investing in blue stocks is that they may not have much opportunity for growth. Often, they have grown as large as they can, and are fighting to maintain or just slightly improve market share.
For example, while we may not be able to imagine a world without McDonald’s, there aren’t many places left for new franchises either. There are, of course, exceptions to this generality, such as when a large company improves access to a previously untapped foreign market. If a developing country suddenly began to provide a market for a large company’s product, that company could experience fast, sudden growth.
Frequently, blue chip stocks see prices rise during times of economic uncertainty. This is because investors flock to these safer stocks. For their stability and dividends, blue chips can make up a valuable portion of well-allocated portfolios of many different investors with many different goals.
If you find blue chips attractive, consider your investing goals and determine how much of your invested dollars belong in blue chips, rather than growth stocks or other assets, such as corporate or public bonds.Topics: Investing