What are blue-chip stocks and how do you trade or invest in them?

What are blue-chip stocks?

Blue-chip stocks are the shares of businesses that are highly reputable, financially stable and long-established in their sector. Over time, the companies considered to be blue chip tend to change – only 40 of the original ASX 200 companies listed in 2000 remained on the index by 2020.

In simple terms, a company is considered to be blue chip if it's near the top of its sector, features on a recognised and high-volume index and has a well-known brand.

What does it take to be blue chip?

The exact requirements to be termed a blue chip are – unusually for the financial sector – vague. Opinions vary from investor to investor, but broadly speaking, the company needs to:

• Be at or near the top of its sector
• Feature on a recognised index (e.g. ASX 200, FTSE 100, US 500)
• Be or own a recognised brand
• Have a history of reliable growth and often consistent dividend payments

The term itself was allegedly coined by Dow Jones employee Oliver Gingold in the 1920s. After observing that certain stocks traded above $200 per share, Gingold denoted them 'blue chips' after the most valuable chip colour in poker across many establishments at the time.¹

It's important to note that some blue-chip companies can still be quite small in relative terms if they operate in a niche sector – with the distinction occasionally blurred between a blue chip and a medium cap.

The opposite end of the investing spectrum is a 'penny stock'. In Australia, these are typically regarded as companies trading for less than $1 per share and with a market capitalisation of under $100 million. However, unlike in the US or UK, this is common understanding rather than a formal definition.

'Blue chip' is also not a standardised term. There's am element of subjectivity in classifying a company as such.

Advantages and disadvantages of blue-chip stocks

Investing in blue-chip stocks is a popular long-term strategy, but these shares are not risk-free.

Advantages of blue-chip stocks

• Blue-chip stocks are usually viewed as low-risk because they tend to post stable earnings, often pay out dividends and have investible credit ratings²
• Dividends combined with reliable capital returns make blue-chip shares among the most reliable portfolio investments
• They are generally also well-trusted by investors because they usually have large market capitalisation – the very opposite of penny stocks, which offer larger rewards but without dividend income, stability or low risk
• There is generally little volatility to worry about, and therefore investing in blue chips requires less investor effort

Disadvantages of blue-chip stocks

• Blue chips are not immune to falls, crashes or even bankruptcy. When negative events happen, such as the 2008 global financial crisis or the 2020 pandemic crash, it can cause substantial damage as a large investor base sells off
• These types of stocks don't experience the short-term price movements needed to generate short-term trading income
• Blue chips are unlikely to generate the higher returns that can be made on riskier investments, such as start-up companies, as they have less room to grow
• They are often in high demand, and therefore investors pay a premium for the lower risk and brand name
• Smaller rivals can eat up market share without careful management

How to trade or invest in blue-chip stocks

How to invest in blue-chip stocks through share trading

1. Create an account or log in
2. Learn more about blue-chip stocks
3. Search for the blue-chip stock you'd like to invest in
4. Choose the number of shares you want to buy
5. Open and monitor your position

How to trade on blue-chip stocks with CFDs

1. Create an account or log in
2. Learn more about blue-chip stocks
3. Search for your blue-chip opportunity
4. Select 'buy' to go long or 'sell' to go short
5. Set your position size and manage your risk
6. Open and monitor your position

With share trading, you own the shares outright. You profit if the share rises in price or if it pays out dividends.

With CFD trading, you predict price movements rather than own the shares yourself. This instrucment is leveraged, so you could gain or lose money quickly – including the potential to lose more than your deposit as possible profits and losses are magnified to the full value of the trade. It's useful to keep in mind that, past performance isn't a guarantee of future patterns.

Learn more about the differences between trading and investing

New to investing or trading? Practise on a demo account to build your confidence.

Examples of blue-chip stocks

The following does not constitute a formal or exhaustive list of blue-chip stocks, but these are some of the largest companies within well-known indices – such as the ASX 200, CAC 40 or DAX.

Again, whether a company remains a blue chip is subject to change over time. But common names include:

• Apple
• American Express
• AstraZeneca
• BP
• Coca-Cola
• Diageo
• Disney
• General Electric
• IBM
• Johnson & Johnson
• McDonald's
• Microsoft
• Nike
• Pfizer
• Unilever
• Verizon
• Walmart

As you can see, most of these companies either are well-known brands or owners of some (for example, Unilever owns dozens of premium food brands). To some extent, whether a company holds blue-chip status depends on the subjective viewpoint of the everyday layman, including its brand perception.

How to identify a blue-chip stock

Classifying most blue-chip stocks is typically not complex given their size, prestige and market-leading specifics - at least from a general perspective. These companies are at the pinnacle of the market and often have wide economic moats – it would be very difficult to supplant Apple or Coca-Cola, for instance.³ They are businesses that trade on exceptional brand loyalty.³

Identifying factors of blue-chip stocks include:

• Lower volatility than shares in companies without blue-chip status due to their institutional profile and strong financial vigour
• Very high liquidity, as they are frequently traded by both institutional and retail investors. This creates a self-fulfilling prophecy, as investors can be confident there will be buyers for their shares
• Usually little debt, high market capitalisation, a stable debt-to-equity ratio, a high return on equity and a high return on assets employed
• Strong balance sheet fundamentals that lend blue chips investment-grade credit ratings
• Usually long and stable history of dividend payments
• Being on a blue-chip index
• Being a bellwether of the wider industry's performance

However, companies considered to be blue chip can change over time. For example, only 11 of the original 30 prestigious Dow Jones stocks in 1987 remained on the index by 2017. Companies including Kodak, Sears and General Motors have exited the index – businesses that at one point would have been considered exceptionally safe investments. In addition, while losing blue-chip status can be difficult, it's equally hard if not more so to attain it. Apple, the world's most valuable company since 2011, was not featured on the Dow until 2015.

Many confuse blue-chip status with simply being very large, but the two things are not the same. A blue chip is almost always large, but large companies are not always blue chip. Consider the AMC Entertainment short squeeze, which catapulted the market cap of the company to many billions – few would have classified the business as low-risk at the time.

Whether blue chips can be considered a good investment is subjective. However, many investors consider allocating a significant portion of their portfolio to these types of large, well-capitalised companies. Often, investors may choose to buy shares in an index tracker which includes many of the most popular blue chips, such as the SDPR Dow Jones Industrial Average ETF Trust.

While blue chips are often viewed as safer than lower-level growth stocks or other risky investments, there is no such thing as completely 'safe' when it comes to investing. General Motors was forced to declare bankruptcy in 2009 after extensive commercial damage caused by the global financial crisis – this was despite once being one of America's titans of industry.

Blue-chip stocks summed up

• Blue-chip stocks are shares of businesses that are highly reputable, financially stable and long-established in their sector
• Companies considered to be blue chip can change over time, for example, only 11 of the original 30 prestigious Dow Jones stocks in 1987 remained on the index by 2017
• Blue-chip stocks are usually viewed as low risk because they tend to post stable earnings, often pay out dividends and have investible credit ratings
• These types of stocks don't experience the short-term price movements needed to generate short-term trading income
• Long-term investors may choose to buy shares in an index tracker that includes many of the most popular blue chips, such as the SDPR Dow Jones Industrial Average ETF Trust

¹ Investment tools, 2023
² Finance Strategists, 2023
³ NerdWallet, 2023