Before the term was used in the financial world, blue chips were the highest valued chips used to bet money in the card game of poker. Typically, a blue chip would be worth anywhere between $10-$25. Blue chips became obsolete as the highest-valued after chips with higher denominations ($50, $100, $1,000, etc.) came in.
However, the term stuck and is now used to define companies that have strong fundamentals and give reliable returns and profits irrespective of the market volatility.
Blue-chip stocks are stocks of those companies that have a long and reputable standing in the market. Blue-chip stocks are known for their stability in turbulent markets. Generally, blue-chip companies are also the leaders in their respective sectors/industries. Stocks of such companies are also known for the consistent dividend returns they give to shareholders.
Why blue-chip stocks yield good return?
Companies fielding blue-chip stocks are well-known for their: i.) lower debt ratios, ii.) diversification in their earnings that compensate losses that should arise in any of its verticals, and iii.) their ability to pay consistent returns and ride out the market trend. Diversification also leads to less fluctuation in their stock prices, thus giving the investor a reliable and profitable performance.
Reasons to invest in blue-chip companies:
1. Consistent returns
When a company has consistent earnings over a period, it earns the trust of its investors. It means the company has got strong fundamentals and the management is striving to maintain its earning capability. For an investor, stable earnings of blue-chip stocks are good for their portfolio and provide decent returns, which is the primary reason for investment.
2. On-time payment of dividends
This is one of the crucial factors that decides the company’s blue-chip status. Consistent payment of dividends means additional income above the initial investment. When an investor invests a substantial amount in a blue-chip company, they will also reap the extra benefits of the dividend. For example, if the investor receives a dividend of 20% on their investment, it means the capital has increased by 20%.
3. Financially sound
Blue-chip companies are well-known for their strong financial base. It means that the company is maintaining a favorable debt-equity ratio, efficient operating structure, lower volatility, minimal risks, and moderates its risk portfolio. These are some of the reasons that make a company a blue-chip.
4. Risk diversification
As blue-chip stocks are known for their stability, it is best to have some of them in the portfolio, especially when an investor is not risk-averse. Even when investing in risky blue-chip stocks, the investor will get the advantage of minimizing losses as these companies are known for their operational efficiency. Blue-chip companies have diversified business interests, a wide range of revenue channels, and a substantial demographic base. These reasons help them moderate risks that would’ve been otherwise incurred by the investor.
5. Goodwill and brand value
Blue-chip companies have their presence in people’s daily lives and have built a reputation as a trusted product of the people. These companies have a competitive edge over emerging companies. They use methods of easy franchise availability, distribution advantage, and cost efficiency to remain market leaders. Some famous blue-chip companies are Procter & Gamble, Reliance Industries, Unilever, and Infosys.
These companies often feature in the Fortune 500 list. These are some of the reasons why one should invest in blue-chip stocks. Blue-chip stocks are, more or less, family heirlooms that can give a substantial return as long as an investor holds on to them.